Mutual funds take a new avataar

Fund houses have finally rejigged their schemes to conform to SEBI’s scheme categorisation norms. Certainfunds have undergone a sea-change in their character and mandate, calling for a total rethink of investment strategy. We highlight significant changes in some categories, to underline what this makeover means to you

Large and Mid-cap: New category

Parvatha Vardhini C

Apart from the usual large, mid, small and multi-cap categories, SEBI’s scheme categorisation norms have brought in a new segment — large and mid-cap funds. These funds need to invest a minimum of 35 per cent of total assets in large-caps and a minimum of 35 per cent in mid-caps. Many existing funds across categories such as Franklin Flexicap (multi-cap), Reliance Vision (large-cap), ICICI Pru Top 100 (large cap), Mirae Emerging Bluechip (mid-cap), HDFC Large Cap (large-cap), Aditya Birla Sun Life Advantage (multi-cap) have now been redesigned as ‘large and mid-cap’ funds.

While this may be a new category for classification purposes, funds did veer into this space in the earlier regime itself. For instance, many large-cap oriented funds added mid-caps to a good extent to their portfolios to boost returns.

But investors were kept in the dark about the heightened risk profile in such a situation. With the changes, investors will now be able to choose this category of funds after understanding the risks upfront. That said, what should investors do about existing funds that have recategorised themselves into this space?

Our take

Mirae Asset Emerging Bluechip has been a star performer in the mid-cap funds category over longer terms of three and five years, recording about 18 and 29 per cent returns respectively during this period. With the change, the fund’s benchmark will now be Nifty Large Midcap 250 index instead of the Nifty Free Float Midcap 100 index.

As per its latest April 2018 portfolio, Mirae Emerging Bluechip has pushed up its large-cap holdings, sporting 41 per cent in this space. Hence, investors have to brace for a lower risk — return profile for this fund in future. If you are looking for a pure mid-cap fund, Mirae Asset Emerging Bluechip won’t fit the bill any longer.

HDFC Large Cap (renamed Growth Opportunities), ICICI Pru Top 100 (renamed Large and Midcap fund) and Reliance Vision, which have been investing predominantly in large-cap stocks until now, will see higher mid-cap exposure in future.

This pegs up the risk profile of these funds. Their benchmarks have also been moved from Nifty 50/BSE 100 to Nifty/BSE LargeMidcap 250 index.

However, the risk-return profile for funds such as Aditya Birla Sun Life Advantage (renamed Equity Advantage) and Franklin Flexicap (renamed Equity Advantage) will more or less remain the same, as their investment pattern is not expected to change after reclassification. Their existing benchmarks will continue as well. Investors in these funds can breathe easy.

Multi-Asset: Total makeover

In an attempt to cut-to-fit schemes to meet SEBI’s norms, a few funds have seen a complete makeover and shift in character. This is particularly true for categories newly defined by SEBI. One such category under the hybrid schemes is the ‘multi-asset allocation’ fund. SEBI has mandated that such funds invest in at least three asset classes with a minimum allocation of at least 10 per cent in each. The somewhat loosely defined mandate is likely to make it difficult for investors to make comparisons within the category . A fund could choose to lean towards any particular asset class — morphing into a debt-oriented or equity-oriented.

Take the case of HDFC Multiple Yield Fund - Plan 2005. It has been a conservative hybrid fund investing 10-20 per cent in equity and the rest in debt instruments. An ideal choice for conservative investors, the fund invests mainly in dividend yield stocks and, within debt, adopts an accrual strategy (lower interest rate risk).

Morphing into a multi-asset fund, it will now have to invest at least 10 per cent each in equity, debt and gold. Going by the new benchmark, the fund has selected (90 per cent NIFTY 50 Hybrid Composite Debt 65:35 Index that is designed to measure the performance of hybrid portfolio having 65 per cent exposure to NIFTY 50 and 35 per cent exposure to NIFTY Composite Debt Index), it appears that the fund is all set to make a drastic shift towards equity.

Our take

If you are a conservative investor, the new HDFC Multi-Asset Fund is not for you. The new category of ‘conservative hybrid funds’ should fit the bill. Investors up for some risk with higher equity exposure, can continue investing in the new fund. Remember, though that will be a change in tax treatment of capital gains under the new scheme. An equity oriented fund now, long term capital gains (above Rs 1 lakh) will be taxed at 10 per cent (without indexation) if held for a period of more than one year.

The other scheme from one of top fund houses that has been bucketed into the multi-asset category is ICICI Prudential Dynamic fund, one of the popular dynamic equity-oriented funds with a corpus of over ₹11,700 crore.

The now ICICI Prudential Multi-Asset Fund, in its earlier mandate had the flexibility to invest fully (100 per cent) in debt or equity. It has invested mostly 65-80 per cent, and up to 97 per cent in equity over the past three years.

As per the new mandate, the fund's allocation can vary across equity, debt and gold, based on market conditions. There could, hence, be notable changes in the portfolio, given the minimum investment requirement of 10 per cent in gold. The benchmark changes from Nifty 50 Index to Nifty 50 (80 per cent), CRISIL Liquid Fund Index (10 per cent), LBMA AM Fixing Prices (10 per cent).

The benchmark suggests that the fund will continue to be equity-oriented. However, the rigid minimum investment requirement in debt and gold could reduce its flexibility somewhat. That said, the fund’s deft juggling between equity and debt in the past and sound track record of returns, are positives.

Hence, its performance within the category should continue to be healthy. Investors looking to build wealth over the long term with exposure to equity, but with a good cover in volatile markets, can continue investing in the fund. Gold and debt can act as good diversifiers in overvalued markets.

Focused Funds: They’ve shrunk

From multi-stock to focused portfolios, a few equity funds have made this transition in the wake of the SEBI’s re-categorisation rules. For instance, Aditya Birla Sun Life Top 100 has morphed into Aditya Birla Sun Life Focused Equity with effect from May 21, 2018. Earlier, Top 100 held up to 100 stocks in its portfolio, most of them large-caps. Now, Focused Equity will hold a maximum of 30 stocks in its portfolio; these too will be mostly large-caps. The benchmark remains the same — the Nifty 50 Index.

In its earlier avatar as Aditya Birla Sun Life Top 100, with annualised returns of about 17 per cent and 12.5 per cent over five and ten years, the fund convincingly beat its benchmark (by 3 to 5 percentage points) and figured in the top quartile in the large-cap category.

The investing style was conservative and defensive, with a predominantly large-cap focus, mid-cap exposure not exceeding 15 per cent even in bull market conditions, and reducing equity exposure in volatile or overheated markets. While this approach sometimes resulted in short-term under-performance in bull markets, for instance, over the past year, it has helped tide downturns better, aiding the fund’s long-term outperformance.

Even now, after the change to Aditya Birla Sun Life Focused Equity, the fund’s investment will continue to be predominantly in large-caps, with leeway for some mid-cap exposure. But the key change will be a sharp reduction in the number of stocks to a maximum 30. The process of reducing the portfolio size has already started — from about 70 in October 2017, the number of stocks has been gradually reduced, down to 46 in April 2018. This is likely to come down further to 30 or less, going forward.

Our take

Should the reduction in the number of stocks be reason to exit the fund? No. Several funds with concentrated, focused portfolios of 25-30 stocks have done quite well in the past with performance comparable or better than funds with larger portfolio sizes. Also, there is financial literature establishing that unsystematic risk (stock specific risk) in a portfolio is reduced to optimum levels in a compact portfolio of 20-25 stocks; that is, the benefits of diversification are optimised in a compact portfolio.

What weighs more on performance is the selection of stocks in the portfolio vis-à-vis the benchmark. On this count, there is no reason to doubt that the past success of fund manager, Mahesh Patil, in Aditya Birla Sun Life Top 100 cannot be continued in Aditya Birla Sun Life Focused Equity, especially with both avatars having a similar large-cap focus.

Hybrid Funds: Well-tailored

Following SEBI’s fund categorisation norms, hybrid schemes have been more rigidly defined compared to the past, with as many as six pre-set categories now. This reclassification has led to extensive changes in the character of some schemes.

One of the best performers in the debt-oriented balanced funds category — Aditya Birla Sun Life MIP II-Wealth 25 Plan — is getting a makeover, as it is set to become a more conservative scheme. Its name changes and three other schemes from the house will merge with it.

The fund is now called Aditya Birla Sun Life Regular Savings. MIP II-Savings 5 Plan (a debt fund with a proven record), MIP and Monthly Income funds are to be merged with Aditya Birla Sun Life Regular Savings.

Aditya Birla Sun Life MIP II-Wealth 25 Plan was a scheme that invested nearly 30 per cent of its assets in equity. The investments were mostly in quality large-caps, with a few solid picks from the mid-cap space as well. Its debt portion is dominated by securities rated AAA, often accounting for 25-33 per cent of the portfolio.

The fund’s five-year return of 12.4 per cent is among the best in the category. Over the last 10 years, the scheme has delivered a healthy 10.5 per cent returns annually. The fund takes active duration calls and does not hesitate to go down the rating curve to AA-rated debt instruments to bolster returns.

The fund also holds around 10 per cent of its assets as cash and current assets across cycles. With the new SEBI guidelines in place, the equity portion would have to be restricted to a maximum of 25 per cent of the portfolio. Thus, Aditya Birla Sun Life Regular Savings would be a debt-oriented hybrid fund with more conservative equity allocation.

The risks associated with higher equity allocation do come down, though the kicker to returns provided during market rallies would be missed.

Among the merging schemes, the MIP II-Savings 5 Plan fund has a consistent track record of beating the benchmark — CRISIL Hybrid 85+15 - Conservative Index — despite taking little or no exposure to equities. Investors in this scheme would have to contend with higher risks after it merges with Aditya Birla Sun Life Regular Savings, given the higher equity exposure.

The MIP and Monthly Income funds have been underperformers vis-à-vis the CRISIL Hybrid 85+15 - Conservative Index, and the merger should help unit holders derive better returns.

Our take

Unitholders of all the four funds can retain their holdings after the merger as well. Given the track record of Aditya Birla Sun Life MIP II-Wealth 25 Plan, consistent inflation-beating returns on a post-tax basis may be expected. Fresh exposure can be considered in the Regular Savings fund through the SIP route to ride out volatility.

Children Funds: Born again

In accordance with the SEBI’s new categorisation norms, child plans that fell under the hybrid category — equity or debt-oriented — have now been given a more distinct slot. Falling under SEBI’s solution-oriented funds, Children Funds have a clear and rigid lock-in feature that brings uniformity across funds within this category.

Earlier, most funds had a lock-in (optional) of three years from allotment or till the child attained the age of 18, whichever was later. Now, as per the SEBI's norms, the lock-in is compulsory and earlier of five years from allotment or attaining the age of 18.

But lock-in aside, there have been other significant changes in certain schemes that investors need to take note of. For instance, ICICI Prudential Child Care – Study Plan that was a hybrid-conservative fund, allocating around 19-25 per cent in equity, is now merged with ICICI Prudential Child Care – Gift Plan with effect from May 28, 2018.

ICICI Prudential Child Care – Gift Plan is a equity-oriented fund, allocating a minimum of 65 per cent in equity.

Hence, if you are a conservative investor and opted for the Study Plan, given its higher exposure to debt, you may need to rethink your investment strategy. Post-merger, your risk increases, thanks to the much-higher equity exposure in Gift Plan. Also, remember that taxation under the surviving scheme (Gift Plan) changes. Being an equity-oriented fund, dividend and long-term capital gains (if sold after a year) is taxed at 10 per cent + surcharge, if any, and cess.

Our take

For investors in the Gift Plan — which is the surviving scheme — nothing changes. The benchmark — CRISIL Hybrid 35+65 – Aggressive Index — also remains unchanged. In fact, given the fund’s sound track record of performance, one can retain the units in the fund.

ICICI Pru Child Care – Gift can help you meet your child’s future expenses over a long period of time with the goal-based investment. Though there is no minimum entry age to invest in the scheme, the ideal entry age would be between one and 13 years.

The fund has been a decent performer in most of the time-frames. Investment through the SIP route has given annualised returns of 11, 14 and 15 per cent for three, five and seven-years respectively, while the benchmark registered returns of 12, 12 and 13 per cent, respectively.

The fund has maintained a well-balanced portfolio, comprising equity and debt. The exposure to equity has been in the 74-93 per cent range in the last three years. Currently, the equity portion stands at 80 per cent, of which 65 per cent is invested in large-cap stocks (as per new AMFI’s classification). The debt portion has maintained a low to moderate duration.

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