Most investors keep it simple by investing in top-rated mutual fund (MF) schemes. The savvy investor digs a little deeper and looks at the preferred category like large cap, mid cap, equity-linked saving scheme (ELSS), etc. They compare the top-rated schemes within that category and look at aspects like performance, risk, style of management and select the scheme which suits their needs. One aspect that remains supreme while selecting MF schemes is past performance, even though it is well known that past performance may not be repeated in the future.
The fund managers style of management plays an important role in delivering consistent returns for the scheme. There are some schemes which remain pure to its style across market cycles, while there are others who employ different styles to generate outperformance. For example, a pure large cap will only invest in large-cap companies, even if midcaps offer better returns potential. On the contrary, a large-cap fund which uses flexibility effectively will dabble in mid caps if opportunities arise. Most likely, the pure large-cap scheme will underperform the other scheme. But are both these schemes really comparable? Will the other scheme be able to generate outperformance, if its flexibility is restricted?
Securities and Exchange Board of India (Sebi) has tried to make peer comparison easier and in this endeavour hit on flexibility of the fund manager to employ different styles. In this changed environment, if investors continue selecting schemes based on past performance alone, they are likely to face disappointment.
Sebi has strictly defined, classified and categorised different MF schemes. They have categorised MF schemes into five major groups; equity schemes, debt schemes, hybrid schemes, solution-oriented schemes and other schemes. Each of these groups has multiple categories. There are 10 categories of equity schemes, 16 of debt schemes, six of hybrid schemes, etc.
The best part, an asset management company (AMC) can have only one scheme in one category. This is expected to affect some larger AMCs which have three-four schemes in the same category. So, what will happen to such schemes? They will be either merged, wound up or their scheme fundamentals will be changed, so that they fit in another category. These changes are expected to take effect from April 2018.
Hence, don’t use the outdated approach of selecting MF schemes where looking at past performance and star rating was enough. Use the new approach which involves having a deeper understanding of MF schemes and selecting schemes which employed a consistent investment style across market cycles. And don’t forget to ignore schemes which undergo change in fundamental attributes even if its past performance is wonderful. The difficulty is, this information is not easily available.
CHANGE FOR GOOD
- Sebi has strictly defined, classified and categorised MF schemes
- Ignore schemes undergoing change in fundamental attributes
The writer is founder and CEO, TBNG Capital Advisors
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