Categorization & Rationalization of Mutual Funds

In the recent two months, investors in Mutual Funds have been receiving communication from their respective fund houses on change of fund names, returns, benchmarks or even mergers with other funds. These changes are as a result of our capital market regulator, SEBI's constant endeavor to make the fund selection process investor-friendly.

Background
Today India has about 40+ fund houses and 3000+ schemes, often carrying names that do not reflect the underlying fund characteristic. This presents great challenge to a retail investor to navigate the ocean of schemes & identify the right funds for him/her. To simplify this process, SEBI in Oct 2017, mandated that all fund houses must categorize their schemes under 5 broad schemes

1. Equity
2. Debt
3. Hybrid (Equity+Debt)
4. Solution-oriented (Retirement, Children's fund)
5. Others (Fund of Funds, Sector/Thematic & Index Funds)

The most useful change by SEBI is allowing only ONE fund under each category by a fund house. This means a fund house having 6 different multi-cap funds would have to merge all 6 under 1 fund and have to name it right to reflect this category.

Sub-Categorization
However, under each of the 5 broad categories of funds, sub-categorization has been permitted as below:

1. Equity - 10 (Large-cap, Mid-Cap, Small-cap, Value Fund etc)
2. Debt - 16 (Short Duration, Credit Risk Fund, Dynamic Bond etc)
3. Hybrid (Equity+Debt) - 6 (Balanced, Balanced Advantage, Arbitrage, Equity Savings etc)
4. Solution-oriented - 2 (Retirement, Children's fund)
5. Others - 2 (Fund of Funds & Index Funds)

While these changes are good for a new investor, it impacts existing investors significantly because a fund could balloon 10x or it could now carry a completely different mandate than before.

Review of re-categorization of "HDFC Balanced Fund"

A big surprise came when "HDFC Balanced Fund's" (AUM Rs.20600 cr) merger with a tiny "HDFC Premier Multi-cap Fund" (Rs.295cr) was announced & the merged fund re-named as "HDFC Hybrid Equity Fund".

• HDFC Balanced fund is now re-categorized as Hybrid Aggressive, which is a good alignment
• The merged fund's new mandate is to invest 65-80% in Equities & 20-35% in debt, closer to its older mandate.
• Earlier benchmark - CRISIL Balanced Fund Aggressive Fund
• New benchmark - Nifty 50 Hybrid 65:35

The only mystery here is why a mammoth fund with an AUM of Rs.20,600 cr fund was merged with a tiny Rs.295cr fund - it would have only made sense to do the reverse merge. The fund house could have done well to explain this move to its long standing investors. In anycase, as the fundamental mandate has not changed much for balanced fund investors, they may consider continuing with the fund.

Rationale behind re-categorization of "HDFC Prudence Fund"
However, in another case, "HDFC Prudence Fund" (AUM Rs.36k cr) is being re-categorized as Balanced Advantage (which means it can be 100% equity or 100% debt or upto 10% in REITs) and merged with "HDFC Growth Fund". The combined fund is re-named as "HDFC Balanced Advantage Fund". 

Fundamentally Prudence was a balanced fund, but now its basic mandate is moved to a completely different class - Balanced Advantage Fund. Prudence Fund investors need to be prudent to evaluate this fundamental change in attribute & take appropriate action.

As the current balanced fund itself has an AUM of Rs.20k+ crores, HDFC fund house probably did not want to merge another Rs.36k crores from Prudence Fund and bloat it to Rs.56k cr. But that does not justify shifting the underlying mandate for many long time investors in Prudence fund.

Time for Portfolio review?
By June 1, most of the re-categorization work is expected to complete. By then, it would be time for existing & new investors to perform a portfolio review with their investment advisors and consolidate / re-align their portfolios to their long term goals.