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Photo: iStock
Photo: iStock

Opinion | We need to recategorise mutual funds for the benefit of retail investors

We need a few well-thought mutual fund categories of equity, debt and balanced

A few years ago, the Securities and Exchange Board of India (Sebi) took the somewhat scattered and large universe of mutual fund schemes and categorized them into buckets. This was meant to achieve multiple objectives—make schemes comparable across fund houses, force asset managers to be truer to label, and also cut down the number of schemes floating around. While this was indeed a good step, this exercise should be a constantly evolving one, especially with the benefit of hindsight of the last two years. It is now time for Categorization 2.0, a process that needs three critical steps.

First, there are too many categories, in equity, hybrids and especially in fixed income. When a retail customer walks into a bank, he essentially has two options—a savings account where he parks short-term money and fixed deposits (FDs) of various tenures (one, three and five years being the most popular). In open-ended debt funds, we have 16 categories, many of which are obscure (like the floating rate fund and the constant maturity 10-year fund) and don’t serve the purpose of most consumers. Many of these were kept in Categorization 1.0 to accommodate existing schemes of larger fund houses, rather than force them to merge. Since these categories exist, those who did not have them are also rushing to fill them. Even the hybrid category has five asset allocation funds, the nuances of which are unclear to most investors. If the ordinary investor wanted to buy a fund in this category, should he or she buy equity savings, balanced advantage, conservative hybrid, multi-asset or hybrid aggressive?

What we need is to run a few well-thought categories in equity, debt and balanced, even if it means taking the difficult decision of merging a lot of assets together. Fewer categories will make funds scalable, create less confusion and mis-buying, and lead to better investment management because the senior management will have fewer debt funds to monitor in their reviews, not 16. I am not arguing that we should not be innovative, but let there be innovation in bringing new asset classes and strategies, and let’s keep our basic domestic equity and debt categories simple.

Secondly, Categorization 2.0 needs to significantly enhance limits and disclosures in the existing categories. The fixed-income categories have tight duration bands, but one can run a short-term fund or a medium-duration fund with any credit profile. When a credit risk category exists, many consumers assume other funds do not take credit risk, but are rudely surprised to find out otherwise. One of the most popular debt strategies which mimics FDs closely is the rolldown or target maturity fund (hold three-, five- or 10-year papers and hold them to maturity), but there is no explicit category for these. As a result, these ideas are executed in corporate bond funds and banking PSU funds, the only two categories with no duration bounds. In fact, one asset management company can run a corporate bond fund with a constant two to three years duration, and one with a duration falling from three years downwards, but the consumer will have no way of knowing the difference. Enhancing limits also means unpopular decisions like ensuring that no fund in the dynamic asset allocation category is running like a static fund. The hybrid category will also benefit from limits on duration and credit quality because investors don’t come to this category to take fixed-income risk. A section again argues that this limits innovation, but simplicity is the best form of innovation.

Finally, where simplicity is concerned, we need to simplify the labelling and names of our funds. It is hard for a consumer to distinguish between the categories of “short term", “low duration" and “medium to long duration" and what they mean for her money. There is a category of funds called “conservative hybrid" in which there are funds with names ranging from “regular savings" to “conservative hybrid" to “savings income" to “debt oriented hybrid". Simplify the names to indicate the purpose the fund serves for the consumer and make sure every fund’s name matches the category name. Moreover, the label of “suited for retail" and “institutional" should be used to denote a few categories as meant for retail investors and the balance for institutional investors. This will ensure that newer asset classes like international funds or funds created for a specific institutional client base are clearly demarcated from categories meant for retail investors.

In the last few weeks, I’ve spoken to thousands of investors—from the average middle-class earner to government employees to very senior professionals. The scheme’s name and label didn’t help 99% of them understand the kind of fund they were investing into. My own father, a retired bureaucrat, a few days ago, gave up on the difference between low-duration, liquid and overnight funds. After 30 minutes of wrapping his head around everything, he said, “Beta, I just needed a savings account."

Shakespeare once said, “What’s in a name? A rose by any other name would be just as sweet." True, in the case of literature, but not in the case of mutual funds.

Radhika Gupta is the chief executive officer of Edelweiss Asset Management Ltd

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