The Securities and Exchange Board of India mandates mutual fund houses to divide equity schemes into 10 new categories. What are the risks associated with each of these segments and what should be the time horizon for investments?
Equity investments are risky and should be done for long term, according to Rajat Jain, CIO at Principal Mutual Fund.
Amit Trivedi, author and a mutual fund expert, agreed. “Investing in equity assets is surely risky and one should have a time horizon of at least five years while investing,” he said on BloombergQuint’s weekly series The Mutual Fund Show.
Both Jain and Trivedi said there were reasonable number of categories for equity mutual fund schemes.
“SEBI has clearly struck a balance by making it simple and allowing flexibility to the asset managers with the new categories,” Trivedi said, adding people now are aware of the too many categories being available. “That’s why there are questions.”
Here are the edited excerpts:
Is the number of categories that still exist in SEBI’s classification too large or would it have been simpler if the number of categories had been slightly lesser? Or is this necessary because of the number of categories which anyway exist?
Rajat Jain: I don’t know if there is a right answer, but it seems to be reasonable. They have been kept relatively straightforward in having a large cap-mid cap; a small, mid and a large cap blend in a few more. We haven’t gone overboard in terms of having many categories and at the same time not having too few. It seems like a reasonable number to me.
Are investors still as confused about the number of categories that exist?
Amit Trivedi: People are aware that there are too many categories now. Earlier, there were too many categories and people were not aware. So, that’s why there are questions. SEBI has to strike a balance between making it simple and allowing flexibility to the fund houses. And they have done a reasonably good job in striking a balance. Whether 16 are enough, or could it be 20 or 14, that could be debated. But they have done a good job and there is a reasonable number.
What is a multi-cap fund and what kind of investors would this fund be suited for?
Rajat Jain: Earlier there was no definition of multi cap. We do have multi-cap stands. This is a totally flexible category. If you look at the market, they have defined what are the large, mid and small-cap stocks. Earlier fund houses could say “this is a large stock for me”, while fund house B can say “we agree broadly with you and these 20 can be large cap to you and not large cap to me”—which is fair. So it is a good overlap.
But what SEBI has done is that every six months, AMFI, the regulatory body for mutual funds, will come out with a list of stocks that they say are large caps. How do they get this? They will look at the market capitalisation, which is market value of stocks across both, the NSE and BSE, and they will average them. And, say based on the last six months, say January to June, these are the market caps, and these are the 100 largest companies based on market capitalisation.
These will be used from July to December. So, everyone knows that these are large-cap stocks. The first 100 names are large caps. Stocks which are ranked 101 to 250 in the same way of market caps averaged across the BSE and NSE, you arrive at a straightforward list, and those are the mid cap names. Everything below that is the small cap category. So, large caps for fund house A are also large caps for fund house B.
For a multi-cap fund, they can invest large across large, mid and small caps in whichever proportion they would like to do. For fund house A, a mid cap could look like one-thirds of fund each. For fund house B, it could be 60-30-10 and so on. So, it is a more flexible category.
Generally for fund houses to manage risk, it could be a mix of large, mid cap and some small cap thrown in. But then multi caps can be run in different manners. There is no real restriction on how you can run a multi-cap fund.
What kind of investors are suitable for multi-cap fund from a risk profile, time horizon or age perspective?
Amit Trivedi: Any investor who is looking at an exposure to equity through mutual funds should consider multi-cap category. Like I am leaving it to the fund manager to decide where to invest my money. Multi cap offers full flexibility of where to invest. If I trust the fund manager, I will select multi cap.
What if I am an equity investor who wants a low-risk fund?
Amit Trivedi: That’s where you start defining where you want to invest. I simply go to a mutual fund and allow him to manage money. That’s where the multi cap comes in. But the moment I know my risk profile and if I say, “I am a low-risk investor”, then I look at only large-cap funds.
But are you happy with an equity exposure being taken at the start from a multi-cap fund as well?
Amit Trivedi: Yes. In the beginning, an investor should get into a multi-cap fund or large-cap fund, not try around a lot of things.
Is the definition of large cap significantly different from the one offered earlier?
Amit Trivedi: Not really, except now the minimum amount limit has been defined by SEBI, and that limit amount should be invested in large-cap stocks, which is 80 percent. Earlier, the offer document decided how much to invest. Let’s say, someone says minimum 80 percent in large cap, so they can go 20 percent in mid and small. If somebody says 65 percent in large cap, then they could go 35 percent in mid and small. Now, that too has been defined by regulation.
Earlier, there were different definitions of large caps as a universe . One fund house said, “I will look at top 100 stocks as large caps”, while someone else came up with the definition that the top 50 is large cap. Somebody defined large caps as a particular market cap cut off. So, there are different definitions. There could be small differences but at least they will have a uniformity across the industry.
Are you happy with new large-cap fund variety? What kind of investors should ideally opt for a large-cap fund?
Rajat Jain: There is not much of a change in the way a large-cap fund ran earlier than the way it is going to run now. Even while there were issues of what large cap really meant, people knew what intrinsically meant a large-cap stock. It won’t be a huge difference for investors in those funds.
From the fund manager’s perspective, there could be some issues. For example, in case of an IPO. Suppose, a new company gets listed in March, although it may be a large-cap company, a large cap is defined by those hundred odd names. So, it will go into the ‘others’category for a while. But then you have a 20 percent leeway. 80 percent have to be in those 100 odd names. If I could have fund house, then it could be that some would narrow the definition of what a large cap is. But it will not hamper your fund manager very substantially and you have a 20 percent leeway available to you as a fund manager.
For large and mid-cap fund, the minimum investment in equity and equity-related instruments in large cap companies is at 35 percent of the total assets. How material would this category be from a multi-cap fund?
Rajat Jain: It is a good category. The kind of funds that have come here, some people who were running mid-cap funds, so they have moved some of their mid-cap funds to this category because they didn’t have a large-cap exposure anyway. Likewise, some who were running some large-cap strategy have moved to this category. It is somewhere between the large- and mid-cap space. So, you need to have 35 percent in large cap, 35 percent in mid-cap space and the balance could be between large- and mid-cap category. Overall, the way it could be different from multi-cap category. Multi-cap is more diversified if we look at it by its mandate. In this, centre of gravity would be more between large- and mid-cap space.
From an investor’s approach, if a multi-cap fund allows me exposure to large, mid and to some extent small cap, then that’s the thing which large and mid cap do as well?
Rajat Jain: Yes, it could. It may be similar to that fund in that category. I think performance should not be too different. That way the multi cap could be more all-weather because it is taken with more diversified bets. But here the centre of gravity will be larger than mid cap.
Amit, you said if somebody wants to take an exposure in the large- and mid-cap fund, the minimum time of exposure should be seven years. Why is it so? Also, does this remain as high-risk category as a multi-cap fund, too?
Amit Trivedi: In terms of risk, there is a marginal difference between multi cap, and large and mid caps. Barring that small-cap component, nothing else is different. I will not say which is higher risk as it is not a significant difference. As far as the time horizon is concerned, may be a few years back I would have said five years, but today I am saying seven years because as the market runs up and the valuations go costlier, one needs to re-look at even the time horizon. Generally, it takes a longer time to earn reasonable returns when the valuations are costly. At cheaper valuations, you may earn your returns faster. That’s the reason why I have increased the time horizon to seven years.