Late last week, something important happened. A lot of the discussion so far between the fund houses and regulators have been around capping of commissions, splitting transaction and advisory roles etc. A whole lot of efforts taken up by SEBI have been to solve conflicts of interest and making investment fees reasonable. Simultaneously, fund houses (along with intermediaries) have been putting forth a case for protecting their distribution channels and protecting their margins, a fairly genuine concern for them. But the directive that SEBI came out with last week, finally, is on the structural reforms for changing the way mutual funds are launched and managed.
The Problem: Fund houses have long adopted the strategy of launch and grow, furiously launching mutual fund schemes with NFOs starting with a NAV of 10 and pitching the retail client to get in early at cheaper NAVs. We've already explained why this strategy, while great for marketing, is just confusing and meaningless for the retail investor here: Why we should NOT focus too much on this very irrelevant metric - NAV. Some of the fund houses have as much as 1100+ schemes that are active!! While a great deal of them are closed-ended schemes, many of them are open-ended schemes too, with a portfolio that could be 95% similar, though with widely different names.
Add to that the scheme classification which could be very vague, even for schemes with similar strategies by different fund houses. This just makes things very troublesome, not just for a beginner investor, but for a seasoned one as well to know the nature of the scheme being invested in.
The Directive: While being discussed for quite some time, SEBI has finally issued the directive to the fund houses to effect the following changes:
1. It has identified the scheme universe (for open-ended schemes only) in 36 categories - With a strictly defined objective of each scheme, as well as the kind of securities the schemes can invest in. This should bring parity for comparison between different schemes of different fund houses.
2. It has restricted one scheme per fund house per category (except for ETFs, FoFs and sector funds). Today there are many fund houses having similar schemes managed by different fund managers. This will bring in a consolidation of schemes for each fund house.
3. Consolidation can be brought by winding up the scheme, merging with a different one, or changing the attribute of the scheme. The AMCs are to submit a proposal for the same within 2 months and affect the changes one month thereafter.
What it means for the investor:
Overall, this is quite a positive move for the industry. Clarity of a scheme objective will always help the growth of the MF industry in the long term, though things may get a little tricky for the fund house to consolidate their schemes and communicate the same to the investors. Here are a few effects for you to take note of:
1. Expect some mails notifying the winding up (less likely) and merger of schemes in about 2-3 months. Investor will have the option to redeem or to accept the merger. In case of a merger, you'll get units of a new scheme in exchange for the current one. This will not have any immediate impact on returns or tax liability. However, with a merger, the objective of the scheme may change and the investor should decide if there is a rebalance required in the portfolio after any such merger.
2. In case of a merger, it is yet not clear if the investment date of the new units will be the same as that of old units for availing tax benefits of the holding period of the existing fund. In case the purchase date is to be taken as that of the old units, it'll be one mighty exercise for the fund house. Think about it - for a user who has a 5000 investment in a daily dividend reinvestment scheme which is now migrated to a new scheme, a fictional purchase date and a NAV history, will have to be built for all the migrated units, for all users. We are not sure if all fund houses will see enough merit in this massive troublesome exercise prone to errors.
3. The classification of debt schemes is purely based on Macaulay duration. While this is good in terms of strict classification of the scheme, this may push the fund managers to play around with credit quality of securities as that is the only degree of freedom they will have. This should especially be true for debt schemes with average maturity more than 1 year, as this is where the classification has been the loosest so far. Users should view any future outperformance with a lens on the credit quality as well.
4. In the short term, expect confusion - for sure. As the industry gears up for the change of fund management, change of scheme documents, migrations of units - their distribution mechanism may have a short setback to migrate the units, re-negotiate/reconsider the trail commissions of the migrated schemes, etc. You know, stuff that ideally should not bother the end investor. Fund managers may be rolled over from schemes and portfolios may be churned to align with the view of the new fund manager, etc.
For a trader, there can sure be opportunities to dig into the underlying portfolio and take positions on expected fund flows, as the schemes that will be migrated are not the small, underperforming ones but could be as large as 10,000+ crores in AUM.
For a retail investors, keep calm and let AMCs and SEBI get their stuff done. The entire ecosystem is getting aligned to make your life better. Just try to be vigilant of the changes in your portfolio for any onetime rebalancing required.
We'll keep following the proposals of various fund houses and message you any actions that can be taken on the portfolio.