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If mutual funds are often touted as one of the best vehicles for you—the small investor—to invest in equity and debt markets, then picking a fund should be easy, right?

That was the intention of the capital market regulator, the Securities and Exchange Board of India (Sebi), when it started the biggest exercise seen in the ₹23 trillion Indian mutual fund industry in recent years—the re-categorisation and consolidation of mutual fund schemes. But a look at the number of categories it has laid out for various fund houses to put their schemes in may have made it tougher for you to pick a mutual fund.

Take the case of equity funds. There are now 10 categories of equity funds. Add four more categories termed as “hybrid” that can have an equity tilt. In short, you have 15 types of equity-oriented funds that you can now choose from. Should you pick one in each of these categories?

Sticking to the core

The short answer is “no”. Experts suggest that investors should not go on a shopping spree just because there are varieties available. The good old large-cap, multi-cap, mid-cap and small-cap funds are still there. But there are some new categories that Sebi has carved out in which some of your existing schemes will now fall. Large-and-mid-cap, value, focused and dynamic asset allocation are some of the new categories. These are old strategies that passed off as plain-vanilla funds in the past, but because they are specialised schemes, they now need to be separate and dedicated buckets.

Most financial experts’ advice is to ignore them. “In most cases and for a normal investor, focus should be on broadly diversified multi-cap funds and large-cap and mid-cap categories; these will serve well,” said Deepak Chhabria, CEO and director, Axiom Financial Services Ltd.

Kaustubh Belapurkar, director, fund research, Morningstar India, said large-cap, mid-cap and small-cap categories should form the core. “You don’t need to pick a fund from each of the categories on offer,” he added.

To be sure, different experts will have different versions of what a core category is, but more or less the consensus among experts we spoke to was that you should limit your search to large-caps, mid-caps, multi-caps and small-caps.

For instance, Ashwin Patni, head-products and a fund manager at Axis Asset Management Co. Ltd, said that the large-and-mid-cap category is a “weird category… just hanging in there and doesn’t really help the investor”. Patni said a better fund to pick stocks across market capitalisations would be a multi-cap fund. A few days ago, Mint carried a story on why a large-and-mid-cap category can get confusing.

Evaluation problem

Why ignore other mutual fund categories? The problem here is how to compare one fund to another when they come with wide mandates or, worse, depend on the fund manager’s interpretation. Take the case of contra funds. A contra fund follows a contrarian strategy that invests in stocks that are out of favour of the market, but those that the fund manager believes would make a strong comeback after some weeks or months or maybe even a year. Now that’s subjective; a company’s shares may be a contrarian story for one fund, but may not be the same for another.

Value funds are somewhat similar and also demand a deeper understanding. “Value funds may underperform in rising equity markets. Will the investor understand why her fund is underperforming or would she think it’s a bad fund? Value funds need patience. Such schemes are best left for savvier investors who can understand what these funds offer,” said Patni.

Another category where performance comparison could get trickier going forward is the dynamic asset allocation category. In this, schemes will be allowed to swing their entire corpuses between equity and debt. ICICI Balanced Advantage Fund, a ₹ 27,600 crore scheme, dropped its pure equity exposure to 35.4% in November 2017 when equity markets had risen throughout the year. A year before that—in November 2016—it held 66% of its corpus in equities.

HDFC Balanced Advantage Fund (formerly HDFC Prudence Fund, an erstwhile balanced fund which has now been re-positioned in the dynamic asset allocation category), with a corpus size of ₹36,415 crore, has seldom held less than 65% of its corpus in equities. According to a brochure that the fund house had shared with us on 3 July, it reiterated that the scheme will continue with its original strategy. How HDFC Balanced Advantage Fund manages its future equity holdings remains to be seen, especially in volatile markets.

“The problem of comparison will come when we compare funds with very broad mandates. Here, investors may need to look at style boxes to ascertain how a fund’s style has been and if the fund is staying true to it,” said Belapurkar.

What should you do?

Fund houses have completed the re-categorisation exercise and have announced their plans. This is a good time to re-structure your portfolio and focus around a few basic categories. Stick to the basic categories—large-cap, multi-cap, mid-cap and small-cap. For large-cap funds, many experts are already suggesting to stick to passive funds. You can tilt towards mid-cap and small-cap funds if you are risk prone or towards large-cap and multi-cap funds if you are risk averse. It’s best to avoid funds that have a wide mandate unless you are comfortable with the fund manager and his style. Talk to your financial advisor for such funds.

Although mutual fund schemes are clearly defined after Sebi’s recategorisation exercise, the number of categories has increased.

Last modified on Wednesday, 11 July 2018

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