Personal Finance

Some takeaways from mutual fund rejig

Parvatha Vardhini C | Updated on January 08, 2018

This clean-up act ensures uniformity and makes fund comparison easier

Over the years, mutual fund offerings by various asset management companies (AMCs) have multiplied manifold. Today, about 850 open-ended schemes are available, making it a mammoth task for investors to pick and choose. This has prompted market regulator SEBI to bring out rules to streamline various open-ended schemes. There are a number of takeaways for investors from the circular in this regard which was put out by SEBI on October 6.

The benefits

The good news is that SEBI has now created five buckets for schemes — equity, debt, hybrid, solution-oriented (retirement, children’s future, etc) and others (ETFs, index funds, fund of funds ). In each of these buckets, there are sub-categories and clear definitions of the composition of the portfolio of the scheme which would be eligible to fall in each of the categories.

A fund house for example, can no longer call a scheme a “balanced” fund and invest say, 80 per cent in equity and 20 per cent in debt and cash. Such a scheme will have to be reclassified as an aggressive hybrid fund. A balanced fund, henceforth, will need to have investments in debt between 40 and 60 per cent and in equities between 40 to 60 per cent. A corporate bond fund should invest 80 per cent of its portfolio in corporate bonds and that too only in the highest rated instruments (that is, AAA rating). Those investing in lower rated bonds will be called credit risk funds. Definitions for large-cap, mid-cap, small-cap stock have been standardised.

For investors, these changes make it easier to compare performances of similar funds. It will also bring down the number of schemes as all offerings will now to have to compulsorily fall under any of these buckets/categories and only one scheme per category will be allowed (barring index funds, ETFs, fund of funds and sector funds).

Kunal Bajaj, CEO and founder,, a SEBI-registered online investment adviser, says that of the 850-odd unique open-ended schemes currently available (including index funds and ETFs), there should be a reduction of around 45-50 schemes through mergers within the same AMC. Investors need to beon the look out for announcements from fund houses regarding the rejig.

The SEBI proposals may also lead to lower costs in the form of lower expense ratios for investors. Currently, for actively managed equity funds, a fund house can charge a maximum 2.5 per cent for the first ₹100 crore (average weekly net assets), 2.25 per cent for the next ₹300 crore, 2 per cent for the subsequent ₹300 crore and 1.75 per cent for the balance. For debt funds, the expense ratio allowed is 0.25 percentage points lower than equity funds. Merger of similar schemes imply consolidation of their assets under one roof and a consequent increase in the size of the continuing fund. This could lead to lower expense which would indirectly boost returns over the long term.

Thirdly, passive funds such as index funds and ETFs may begin to see more interest. This is particularly true for the large-cap category. Currently, many funds which style themselves as large-cap oriented sometimes invest a good chunk in mid-cap stocks and beat their benchmarks and peers by a wide margin.

This may become difficult in future as SEBI has ruled that a large-cap fund must invest at least 80 per cent of its assets in large-cap stocks. Large-caps stocks have been defined as the first to 100th company in terms of full market capitalisation. The fact that passive funds have much lower expense ratios will be an added incentive to move.

Taxation issues

Though there are benefits from this clean-up act, investors need to note the taxation issues associated with merger/consolidation of schemes. From April 1, 2016, units allotted from the consolidated fund to an investor of a consolidating fund is not considered a transfer of capital asset. Hence, capital gains tax does not arise.

However, given that existing funds have to be fitted into straight-jacketed buckets, it is possible that some funds could undergo changes in fundamental attributes. When such issues arise, usually, fund houses have to offer exit option for investors. If you choose to exit, you may have to pay taxes on gains.

Questions arise if you have invested in tax-saving schemes (ELSS) which call for a three-year lock-in. If your scheme ceases to exist, the lock-in and the 80C deduction benefit has to ideally move seamlessly to the merged fund to make it hassle-free. “The tax department could come out with notifications to provide clarity on any grey areas that may arise”, notes Archit Gupta, Founder and CEO, ClearTax.

Published on October 15, 2017

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