The last major reform that we saw with respect to mutual funds was in the mid to late 2000s when the mutual funds were first allowed into derivatives and later the imposition of entry loads was banned by SEBI. The first measure led to MFs becoming a critical player in the institutional F&O market while the latter was largely investor friendly and led to the rise of direct plans, which are more cost-effective for mutual fund investors…
Currently the SEBI is considering two key changes to make mutual funds more transparent. Firstly, the regulator is planning to shift all the funds to benchmarking their performance based on the Total Returns Index (TRI) rather than on the absolute returns index. Secondly, SEBI is planning to push through a major consolidation of schemes with similar characteristics so that the fund message becomes clearer to the investor. Let us look at these two points in greater detail…
Currently, mutual fund performance is benchmarked based on absolute returns. Let us assume that you are benchmarking the performance of an equity mutual fund against the Nifty for the last one year. If the Nifty 1 year back was at 8200 and the level of the Nifty today are at 9900, then the absolute return of the index will be 20.73%. The equity fund will be benchmarked based on these returns. So if during the same period, the equity fund has given a return of 22.75% then the fund would have outperformed the benchmark by 202 basis points.
The big drawback in the above calculation is that while the fund has been receiving dividends from the equity stocks that it has been holding, we are not considering the dividends received had you held on to the portfolio of index stocks for the last 1 year. Let us assume that the Nifty has a dividend yield of 1.50%, which has been the average dividend yield that the Nifty has enjoyed over the years. Under the TRI, the new benchmark returns will be 22.23% (20.73% + 1.50%). Now the outperformance of the equity fund has come down from 202 basis points to just 52 basis points.
This aspect has been under discussion within the MF committee of SEBI and is likely to see a decision soon. Currently, for any investor choosing from among 38 AMC with nearly 3000 schemes and over 20,000 plans is hardly an exciting job. The primary confusion arises because within the same AMC, you have multiple schemes with the same asset mix and similar investment objective. That is not only confusing for the investor but also results in additional products without any differentiation. For example, a large AMC may have an equity fund, a growth fund, a capital appreciation fund and an asset builder fund; and all these funds may essentially be equity diversified funds. That is surely a lot of duplication.
What the SEBI proposes to do is to clearly define categories like equity, large cap, mid cap, small cap, sectoral funds, thematic funds etc. Each AMC will be allowed to have only one scheme under each of these categories. If a fund has multiple schemes under the same categorization, as stated in the example above, the AMC will either have to consolidate these schemes or they will have to shut down additional schemes with similar asset mix. SEBI will classify mutual fund schemes under 3 broad categories viz. Equity, Debt and Hybrid and all funds will have to adhere to this definition.
Both the steps proposed by SEBI are a welcome shift towards greater transparency among mutual funds. In the process, the investors will be the key beneficiary!