If a mutual fund scheme changes its indicative asset allocation as stated in its scheme information document, but proposes to follow its erstwhile strategy, do we have a new scheme on our hands or is it the same old scheme? That’s the question we’re asking after seeing the way HDFC Asset Management Co. Ltd has gone about merging its erstwhile balanced funds. The scheme consolidation and re-classification in the ₹ 23 trillion Indian mutual funds industry, initiated by capital market regulator Securities and Exchange Board of India (Sebi) in October 2017, is complete. But two curious cases, ironically both from HDFC AMC, stand out.
Effective 1 June 2018, the erstwhile HDFC Prudence Fund was converted into HDFC Balanced Advantage Fund. The path was slightly complex. It first converted HDFC Growth Fund, a small equity-oriented fund of ₹ 1,129 crore into HDFC Balanced Advantage Fund and then merged the flagship behemoth HDFC Prudence Fund ( ₹ 36,594 crore corpus) into it.
But in a communication that the fund house sent out to all its distributors in the past two months, it said nothing has changed with the erstwhile HDFC Prudence. Mint has a copy of the communication sent to distributors.
But isn’t HDFC Balanced Advantage supposed to be different from HDFC Prudence? HDFC Prudence, an erstwhile balanced fund, could invest 40-75% in equities and the rest in debt. In its new avatar, HDFC Balanced Advantage can invest its entire corpus—or practically nothing—in equities, and the rest in debt. In other words, it can swing completely between equities and debt. Then, why does HDFC AMC claim that the erstwhile HDFC Prudence and the new HDFC Balanced Advantage are the same?
There’s more. The erstwhile HDFC Balanced Fund became HDFC Hybrid Equity Fund. Here again, HDFC Premier Multi-Cap Fund (a tiny equity fund with a corpus of ₹ 295 crore) was converted into HDFC Hybrid Equity and then HDFC Balanced ( ₹ 20,401 crore) was merged into this concoction. Here too, apart from a minor tweak (the fund calls it “no material change") in its stated asset allocation (what every scheme states in its scheme information document), the rest remains the same (“no change", as the fund house calls it). That HDFC AMC has chosen to put its Hybrid-Equity Fund in the “aggressive hybrid" category is normal as most erstwhile balanced funds in the industry (those that invested at least 65% in equities and the rest in debt) have chosen to remain in this category.
If HDFC Hybrid Equity would continue to invest 65-80% in equities and HDFC Balanced Advantage too continues to invest as per its original avatar (around 65-75% in equities), then what’s the difference between then and now? Is the AMC using nudge-nudge, wink-wink to tell distributors that the scheme mandate is not to be taken seriously and that HDFC Prudence will remain what it was?
By doing these manoeuvres, HDFC AMC has managed to keep the two balanced funds the way they were managed earlier, despite Sebi’s attempt to consolidate the scheme and remove duplicity within each category of funds. HDFC AMC refused to comment for the story.
What’s the fuss?
When Sebi had initiated the re-categorisation exercise, it said, “It is desirable that different schemes launched by a mutual fund are clearly distinct in terms of asset allocation, investment strategy etc." This was its first justification about why it had embarked upon this big an exercise. But if HDFC AMC’s two erstwhile balanced funds continue life as usual, as their communication to investors indicate, then is HDFC AMC violating Sebi’s guidelines?
The MD of another fund house said: “HDFC Balanced Advantage continuing with the strategy of HDFC Prudence is dangerous for new investors. Usually, balanced advantage funds reduce their equity exposure when equity markets turn volatile. By nature, investors will expect lower volatility. But since HDFC Balanced Advantage will not swing between equity and debt and instead will continue the way HDFC Prudence was managed, investors will not get a ‘true-to-label’ fund. The fund perhaps thinks that since its brand is so strong, they will get away with it."
The continuation of the old larger funds despite new names is not the only dichotomy. A former industry official, who spoke to Mint on the condition of anonymity, told us that if the asset allocation pattern, as stated in the offer document, changes, then it becomes a new fund. But the fund house has chosen to display past performance of HDFC Prudence and HDFC Balanced. This, despite the fact, that HDFC Prudence “has been merged into" HDFC Balanced Advantage and HDFC Balanced “has been merged into" HDFC Hybrid Equity. If HDFC Prudence and HDFC Balanced, therefore, cease to exist, why then is the fund house demonstrating their past performances?
In a Sebi circular dated 12 April 2018, titled “Performance disclosure post consolidation/merger of schemes", the regulator laid down detailed guidelines as to how fund performances should be displayed (and when past performances should be buried) when two schemes merge. If two schemes merge and a third scheme emerges, then the past performances of both the merged schemes should not be shown.
Hence our second question. Are HDFC Balanced Advantage and HDFC Hybrid Equity new funds? Or are they just old schemes with new names? And if they are old schemes and nothing has changed, as per HDFC AMC’s communication, then why not just merge the small schemes into the larger ones? Better still, why not just merge the two balanced funds and create one giant fund?
Best of both worlds
The answer lies in the two old and large schemes’ legacies that HDFC AMC has intended to protect and continue, while still complying with Sebi regulations, even if just on paper presumably.
Industry officials said that HDFC AMC resorted to these unique mergers to ensure continuity in its dividend paying strategies. Read about how balanced funds lured investors on the pretext of paying regular dividends here.
At the forefront of the dividend saga has been HDFC Prudence that has built a formidable track record of paying regular dividends. But since Sebi rules mandate that dividends need to be paid out of only booked profits, any fund that aims to pay regular dividends needs a good amount of reserves in its balance sheet to pay dividends. A comparison of HDFC Prudence’s and HDFC Growth’s balance sheets tell us that the latter’s capacity to pay dividends is more than the former. “Higher reserves also ensure that in future when equity markets go down, the fund is still able to pay dividends (out of profits booked earlier but not yet distributed)," said the head of operations of a fund house who did not wish to be named. Therefore, to be able to continue to pay dividends, it became imperative to merge HDFC Prudence (the larger fund) into HDFC Growth (the smaller fund).
HDFC AMC’s communication to investors of HDFC Prudence’s investors that we spoke about earlier also mentioned that there would be “no change" in the “monthly" dividend frequency of the fund (HDFC Balanced Advantage).
In short, HDFC AMC has retained the strategy of HDFC Prudence (the merged fund) as it comes with a better past performance than HDFC Growth. But it has retained the balance sheet of HDFC Growth (the surviving fund) owing to its higher dividend paying flexibility. In doing so, it hid behind a clause in Sebi’s 12 April circular about retaining strategies, instead of another clause in the same circular that spoke about a new scheme born out of a merger. Read about the clauses here.
Alluding to HDFC Prudence, the CEO of a small-sized fund said, “HDFC AMC’s stance is understandable. How can it lose past performance of such large schemes with so many investors, especially if the fund has the same fund manager for the past 20 years." But he added that despite being called a balanced advantage fund, it won’t be a true balanced advantage fund. The dividend saga clearly appears to have influenced in the way they have merged.
This way, HDFC AMC has had its cake and eaten it too.