Mutual funds in India

Mutual Fund Product offerings are regulated by SEBI

The Securities and Exchange Board of India (Sebi) has introduced detailed guidelines for determining the place of a mutual fund on its riskometer tool. The new system introduces a fresh category of 'very high' risk. It replaces the old model based simply on a scheme's category without adequately considering its actual portfolio. The circular goes into effect on 1st Jan 2021. Mutual Funds have to update the riskometer on a monthly basis on their websites and the AMFI website, within 10 days from the end of the month. In case of a change in riskometer position, they have to send out communications to investors. Mutual Funds also have to publish a history of riskometer changes every year.

Under the new riskometer, there are six categories of risk, going from low to very high. Debt schemes with lower rated credit or higher maturity papers will be determined as more risky. For equity schemes higher risk weights will be given to small and mid cap stocks (meaning a riskier place on the riskometer tool). The new Sebi circular also introduces a liquidity parameter for both equity and debt schemes, assigning higher weights to schemes investing in relatively illiquid securities. "Many key changes have been introduced. Now investors will be able to distinguish between the risk of funds within a category. The monthly publishing also makes it a dynamic tool. An additional risk category called very high has also been introduced. All these changes are welcome," said Swarup Mohanty, CEO, Mirae Asset Mutual Fund.

SAMEDAY NAV 
Sebi issued a mutual fund circular to change the NAV rules. From January 1,2021, investors will get the purchase NAV of the day when investor's money reach AMC. "It has been decided that in respect of purchase of units of mutual fund schemes (except liquid and overnight schemes), closing NAV of the day shall be applicable on which the funds are available for utilization irrespective of the size and time of receipt of such application," said the Sebi circular.

MULTICAP VS FLEXICAP 

In the year 2020, market regulator SEBI issued guidelines to make multi-cap funds more true-to-label by enforcing minimum exposure to large, mid and small-cap stocks. While a few AMCs (asset management companies) adjusted their multi-cap funds as per the mandate, several converted their existing multi-cap funds to flexi-cap schemes so that they could continue with their large cap-heavy portfolio allocations. As of end-April 2021, the market had around 25 flexi-cap funds with Rs 1,59,480 crores of AUM, and 12 multi-cap funds with Rs 19,846 crore in AUM.

 

New fund offers in both, multi and flexi-cap schemes, have continued to hit the market as AMCs try to ensure their presence in both categories. With both fund categories designed to invest across large, mid and small-cap funds, differentiating between multi and flexi-cap schemes can seem like a confusing task for retail investors.

Is it only a difference of the degree to which each invests across market capitalization? How large can this difference be? And what can be the possible impact on risk and return?

The capitalisation spectrum

The mid and small-cap segments in the capital market offer a larger universe of less-discovered stocks to choose from. This means two things: 1) fund managers have greater scope to use bottom-up strategies to identify potential winners and, 2) these segments of stocks can face liquidity issues as they may not be frequently traded.

Another important aspect is the ‘beta’ of mid and small-caps. Mid and small-caps can be disproportionately impacted by market movements, which means they are usually more volatile than large cap stocks. Because of these characteristics, investing in mid and small caps is considered a relatively high risk-high reward venture, requiring a long-term mind set.

The difference between multi-cap and flexi-cap funds

The key difference between multi and flexi-cap funds is of the degree to which they are exposed to mid and small-caps. More importantly, this difference can become quite large depending on market conditions. Flexi-cap funds can dial down their exposure to mid or small caps right down to zero, if the fund manager deems it necessary; however, in the case of multi-cap funds, this exposure can never go below 25 percent each for mid and small-cap stocks.

To understand this better, let’s look at the SEBI mandated difference as well as the actual current portfolio allocation of multi and flexi-cap funds.

Current Market Cap Allocation in Multi and Flexi-cap Funds

The allocation chart clearly shows that, on average, flexi-cap schemes are currently maintaining a large-cap heavy allocation, while multi-cap funds are focusing on small cap stocks to generate alpha.

Deciding suitability

In our view, both fund categories have a clear mandate, and will adopt distinct strategies to cater to investors with different risk profiles and return expectations.

The multi-cap category offers fund managers the scope to showcase their stock-picking skills and the potential to create alpha. The mandatory exposure across capitalisation does, however, pose a risk – the fund manager has limited scope to reduce exposure to any segment of market cap that is expected to do poorly at any point in time. The onus of managing the liquidity challenges that come with investing in small-cap stocks is on the AMC and its risk management frameworks.

Investors who are happy with a fixed allocation as their optimum exposure across capitalisation, and have a relatively high risk appetite can consider multi-cap funds. These investors would also need to have a longer investment horizon to allow for the fund’s strategies to bear fruit.

The flexi-cap category does not have any fixed minimum allocation across market capitalisation, making the fund manager’s conviction and skill at judging the right allocation important. The fund manager evaluates the growth potential of different companies, regardless of their market cap and invests in them. Flexi-cap managers can track when a particular market segment has become unattractive, and change the allocation to an alternative market segment that has performed well recently.

 Investors who prefer flexible exposure across market capitalisation can thus consider flexi-cap funds. However, they should evaluate whether the fund is managed dynamically according to the prevalent opportunities in the market, and has delivered consistent performance that can meet their investment goals.