Mutual Fund Trends that alters your future - Oct 2021

 The year 2020 was painful for the Indian mutual fund industry. After a surge in flows during the covid-19-driven stock market crash in March, the industry saw sustained net outflows from its equity schemes, a much-watched barometer. The outflows coincided with record number of new demat accounts, expected to touch 10 million in FY21, suggesting that India’s retail investors were dumping mutual funds to try their luck in the stock market.

 

In addition to regulatory changes, there were market innovations also during these pandemic days.

A. Regulatory changes

 

The market watchdog- Securities and Exchange Board of India, brought in a slew of new rules and regulations to make mutual funds more transparent and investor-friendly, prominent among them are as follows:

  

1.      Change in investment mandate of multi cap funds

  

In September 2020, Sebi issued a circular changing the portfolio mandate of multi cap fund schemes. According to the new rule, multi cap funds will have to invest a minimum of 25 % each in large cap, small cap and mid cap stocks from January, 2021. This will take the overall equity exposure of these schemes up to 75% as opposed to the current minimum equity exposure of 65%, with no market cap limits.

This move aims at making multi cap funds ‘true to label’  and hold a well-diversified portfolio. Most multi cap funds had a large cap bias with almost minimum or no investments in small cap stocks. Many fund houses spoke about converting their existing multi cap schemes to ESG funds or Focused funds to avoid the new mandate

 

2.      Introduction of flexicap category

 

The change in mandate for multi cap schemes did not go down well with many big fund houses. Many top fund managers and CIOs spoke against the move and said that this will make the category risky for investors.

The major issue with the change was a mandatory 25% exposure to small cap stocks. On November 06, Sebi intervened and issued a circular for the introduction of a new mutual fund category- Flexi Cap Funds. Flexi cap funds are a new name for the old multi cap funds- a category that is market cap agnostic and has to have a minimum equity investment of 65%

3.      Change in NAV calculation

 

SEBI also tweaked the rules for NAV calculation in mutual funds this year. According to the new rules, investors will get the purchase NAV of the day when investor's money reaches the asset management company (AMC), irrespective of the size of the investments. This rule comes into effect from February 1, 2021, and will not be applicable to liquid and overnight funds

4.      Tightened inter-scheme transfer norms

 

In wake of the liquidity crisis triggered by the Covid-19 pandemic, many fund houses were trying to maintain liquidity in some short duration debt schemes by transferring bad credit to either balanced funds or to longer duration schemes. Sebi came out with new rules to protect investors' money from getting impacted by this process

From 1 Jan, 2021, inter-scheme transfer in close-ended funds can only be done within 3 business days of the allotment of the scheme’s units to investors and not thereafter. Furthermore, SEBI took cognisance of the movement of bad credit from one scheme to another and directed that fund houses shall not be allowed to transfer debt papers to another scheme if there is any negative market news or rumour about a security in the media or if an alert is generated about a security for its risk levels.

5.      Advisor distributor segregation

SEBIi also mandated the long-pending segregation of advisors and distributors this year. This was done primarily to address the issue of mis-selling and overpricing of services given to retail investors. According to the new rule, a company with both advisory and distribution arms can either provide financial advice or sell products to its clients. Individual planners and distributors also have to choose one of the jobs and  register accordingly with AMFI

6.      New risk-o-meter label

To help investors make better decisions about their investments in high risk mutual funds, Sebi introduced a new category on the risk-o-meter. Apart from the existing five categories of risk, ‘Very high’ risk category will also be seen on the risk-o-meter tool. Sebi also directed fund houses to disclose and evaluate risk basis the portfolio of the particular scheme and not the category. From January 1st, 2021, fund houses are required to make monthly risk-o-meter public along with the portfolio disclosure

Old	New 01 Jan 2021

 

 

7.      Dividend options renamed

Mis-selling in the name of regular dividends is an old practice in mutual funds. Sebi finally took action to bring more transparency to the dividend payouts in mutual fund schemes and directed fund houses to clearly mention that the dividends might be paid from their capital. Hence, from April, 2021, dividend options in the existing as well as new schemes will be renamed to clearer, more transparent nomenclature. The dividend payout option will be renamed as income distribution cum capital withdrawal option. Dividend reinvestment option will be renamed as re-investment of income distribution cum withdrawal option and dividend transfer plan will be renamed as transfer of income distribution cum capital withdrawal plan

8.      Norms to bring in more transparency in debt securities transaction

SEBI tweaked the disclosure norms for debt mutual funds this year to help investors understand the risk levels in the portfolios early. According to the new norms, fund houses will have to disclose the yields of the underlying instruments of the scheme, along with the portfolio on a fortnightly basis.

The portfolio disclosure used to happen on a monthly basis before the new rule. Fund houses used to disclose only the indicative yield of the portfolio and not the specific yields of the securities. Mutual fund advisors say that this move makes debt mutual funds more transparent and credit risk a little more predictable in these schemes

 

9.      Skin –in-the-game Policy

 

The phrase refers to owning the risk by being involved in achieving a particular goal. Best known as ‘Hammurabi’s code’, it is named after King Hammurabi (Mesopotamia, 1972-1750 BC), who laid out this set of laws to manage risk. Three concepts associated with this code are reciprocity, accountability, and incentives.

Currently, an AMC has to maintain a networth of Rs 50 crore. Sebi’s panel has proposed that fund houses be allowed to make investments in their own schemes from their networth. To ensure the interests of asset management companies (AMCs) are more aligned with those of unitholders, SEBI’s board approved scrapping the Rs 50-lakh cap. Instead fund houses will have to invest, based on the risk profile of the schemes. The risk profile will be in accordance with the existing labels under the risk-o-meter framework.

According to a disclosure bySEBI, AMCs will have to invest 0.03 per cent in schemes with ‘low’ risk profile and 0.13 per cent in schemes with ‘very high’ risk profile, which are typically equity schemes.

Fund houses could get up to a year to meet the norms. Certain MF schemes, such as exchange-traded funds, index funds, overnight funds, and fund of funds, are exempt from the skin-in-the-game requirement.

The move is part of a series of steps taken by SEBI to ensure transparency and responsibility at AMCs.

In April 2020, the regulator had said 20 per cent of the salary of senior MF executives will have to be paid in the form of units of schemes they oversee. The above unit based compensation will have a lock-in period of minimum three years or tenure of the scheme. If there is any code of conduct violation by the employee, it will be subject to claw back. These norms were to become applicable from July 1. Following industry feedback, SEBI has extended the implementation date to October 1.

 

 

B. Industry driven changes

1. Portfolio construction

After witnessing a roller-coaster ride in their equity investment in 2020, investors are likely to focus on asset allocation and diversification. This means not only investors would focus on investing in other asset classes such as debt or gold, they will also look to diversify their portfolio within a particular asset class. For instance, investors may opt for a combination of active and passive strategies and invest in funds that take exposure to international stocks.  

The low interest rate regime lead investors to seek equity investment in 2020. He, however, believes that investors will protect their downside with asset allocation and diversification in 2021.

The year 2021 began  the trend of acknowledging the passive strategy in the core portfolio. Investors will invest in a combination of active and passive funds to grow wealth in 2021.

Another key trend would be exposure to international stocks through mutual funds. The industry has started offering products that give investors exposure to international investing. This trend will gain traction in 2021. The investors will also increase their investments in real estate and multi asset funds for better diversification which is already started manifesting..

a). Domestic-global MF

Although not formally a mutual fund category, this model was pioneered by PPFAS Mutual Fund in its flagship scheme PPFAS Long Term Equity. This model invests up to 35% of an equity fund’s assets into foreign stocks, with the rest in domestic Indian stocks. This allows the scheme to continue to be taxed as an equity fund under Indian tax law.

PPFAS Long Term Equity saw its assets under management (AUM) more than double from around ₹2,500 crore at the end of December 2019 to ₹5,757 crore at the end of November 2020. Returns of 33.5% (as of 29 December, according to Value Research data) since the start of the year account for some of this growth, but robust inflows are the dominant contributor.

Other AMCs have begun to adopt the model. Axis Mutual Fund adopted it in its Growth Opportunities Fund, ESG Fund and Special Situations Fund, while DSP Mutual Fund used it in its Value Fund launched in November seeking value opportunities in India and abroad.

Some AMCs such as Tata Asset Management have simply amended the mandates of existing schemes to include global investing. Even SBI Mutual Fund, India’s largest fund house by assets, has taken a partial exposure to global stocks in its Focused Equity Fund.

A 65:35 domestic to international equity structure provides a tax-efficient route to international investing. Diversification is another advantage.

b). Roll-down maturity

Debt mutual funds in India have long struggled with the problem of being unable to explicitly guarantee returns. This turns retail investors towards fixed deposits and bonds (even risky ones) as they come with a fixed interest rate.

Roll-down maturity is the industry’s response to this problem. It involves specifying a target maturity date and holding bonds whose maturity roughly corresponds with the date in question. This allows the fund’s return to be predictable if it is held till the target date, although there’s no explicit guarantee.

The strategy is being seen as a successor to fixed maturity plans (FMPs) which suffered post the IL&FS debt crisis in 2018. “Roll-down is an evolution over FMPs which suffered from the limitations of being closed-end. The discourse around roll-down is also about its structure and ability to deliver a predictable return rather than tax which was the selling point of FMPs.

The roll-down structure is used in open-ended funds, allowing investors to exit at any point of time, unlike the lock-in of FMPs. If the debt scheme in question is held for more than three years, investors are taxed at 20% on capital gains and given the benefit of indexation, giving them an advantage over FDs. Further, if the bonds held by the roll-down scheme are high quality, there is more certainty on returns.

The concept was popularized by the Bharat Bond ETFs (Exchange Traded Funds) which were launched in December 2019 and again in fresh tranches in mid-2020 and has been adopted widely across the industry.

c.) ESG Investing

ESG or Environmental, Social and Global Investing is an idea that caught on in 2020. ESG philosophy seeks to weed out companies which fail to satisfy specified norms on corporate governance, environmental impact or social awareness. Until 2019, there were only a couple of ESG schemes, but in 2020, most of India’s large AMCs, including Aditya Birla Sun Life, Axis, Mirae, Kotak and ICICI Prudential, launched such schemes.

The jury is out on whether the trend is more than a marketing gimmick, but experts largely favour it.

 2.  Entry of new players

SEBI’s relaxed norms on who can foray into MF business can attract many fintech players. Until now, the regulator required entrants to demonstrate three years of profitability and maintain a net worth of Rs 50 crore. However, SEBI has now done away with the profitability norms. Now, companies will be eligible to sponsor a mutual fund if they have a net worth of Rs 100 crore.

These relaxed norms will attract many fintech players to start their mutual fund business. Now that it is not mandatory to show 3 years of profitability, many fintechs can enter the MF industry. The entry of new players could also lead to mergers and acquisitions.

Fintech firms, which provide and rebalance model stock portfolios at low cost, tied up with brokerages, disrupting the very USP of the industry. However, within all the gloom and doom, a few new models have taken root and may yet rescue mutual funds in 2021.

This is interesting to have watched: From solitary UTI to bank sponsored, FI sponsored, Brokerage sponsored to Fintech sponsored MFs have tweaked the expenses of investing in equity market bringing down the distribution expenses, transaction expenses, increasing ease of doing business and overall decreasing dealing time with seamless opportunities. 

 

3. Wider participation using technology

With more new players and use of technology, the year 2021 witnesses increased participation from the remote areas of India and young investors.

The industry has swiftly moved to digitaltransactions and virtual communication in 2020. This will pave the way for MF industry to reach out more investors in the hinterland in 2021.

The MF industry will penetrate deeper into smaller cities with the message of consistent investing via SIPs. Delivering the message in the local idiom and more intensive coverage through feet on the ground will be the key to increase penetration in B30 cities. Further, the industry will focus on improving digital efficiency to attract millennials.