Recently, SEBI issued a circular rationalizing the categorization of mutual fund schemes. We believe that this would have two major consequences for mutual fund investors, as some of the schemes would need to be modified in order to meet the criteria of the circular. Click here to read our article discussing both these.

The English translation is as under:

Mutual Fund scheme categorization – evaluating a scheme

As we discussed earlier, in November 2017, SEBI issued a circular rationalizing the categorization of mutual fund schemes. This would have two major consequences for mutual fund investors, as some of the schemes would need to be modified in order to meet the criteria of the circular. We will take up both these here today.

First of all, when a scheme undergoes a change in where it can invest, or how would it be managed, the past performance of the scheme may become completely irrelevant. Let us take an example:

A scheme had investment objective of generating growth in capital through investment in equity shares. However, post the rationalization, the scheme is modified in that it would now invest only in shares of large companies.

In such a case, the past performance might have come from investment in shares of mid and small sized companies. Going forward, with the change in scheme objective, the scheme would be allowed to invest only in the stocks of large companies.

This would mean that the past performance has no relevance now.

While the above point may appear to be making life difficult for an investor, the question one may think of is: how does one select the scheme, if the past performance is irrelevant? While we may have a separate discussion on how to evaluate past performance of any scheme or a portfolio, we would restrict the discussion today in light of the two consequences of the said circular.

The second consequence of the circular is a positive one for the investors, and also provides the answer to the question above. The schemes have to be categorized as per the categories defined in the circular. At the same time, a mutual fund cannot have more than one scheme within a category barring a few, e.g. sector/thematic funds, or funds-of-funds.

This should help an investor looking for a particular kind of scheme. One has to decide on the category to invest in and then pick up a scheme within that. The job becomes relatively easier.

So, next time you want to invest in a mutual fund scheme, decide on the category to invest, which should be a function of your specific situation, your risk profile and time horizon. Once you have done that, picking up a scheme from within the category should be easier.