One of the primary reasons that SEBI had not just classified but also defined equity schemes into large-cap, mid-cap, small-cap and more a few years ago, was to ensure adherence to label. Till then, so called 'bluechip' or similar named funds were getting away with holding a high percentage of small cap stocks when the wind was blowing in that direction. Post the classification order, an AMC will need to label such a scheme as either a pure small-cap or flexi-cap fund.
It is against this backdrop that SEBI recently indicated that even passive breaches within a mutual fund scheme will no longer be tolerated, as it defeats the very purpose of labelling. SEBI has ordained that fund houses must remain true to their label by fixing passive breaches in their schemes within 30 days.
So, what is a Passive breach and when does it occur? A Passive breach happens when allocation to certain asset class or an instrument changes due to market movement or fund management strategy. To cite an example, a large cap fund has to maintain 80 % exposure to large cap stocks. If however, due to volatility or an internal fund management call, the overall allocation to large cap stocks reduces to around 75 to 76% (merely indicative, not sacrosanct), it will be tantamount to a passive breach.
Thus far, there was no time limit to fix passive breaches. As a result, a few fund houses maintained allocations that were not in line with the scheme's mandate. SEBI's new norms will ensure that the fund house maintains its allocation to remain true to its label. This rule is applicable on all active schemes except overnight funds.
In case a fund house does not adhere to these norms, it will have to explain reasons for the breach to the investment committee. The committee may provide it time of 60 more business days to the mutual fund to fix allocation, if it accepts the explanation provided. If AMCs fall out of line in this context, SEBI will bar the fund houses from launching new schemes. The market regulator will also not allow non-complaint fund houses from charging investors wishing to redeem, any exit load during the period.
SEBI has announced that in case the AUM of deviated portfolio is more than 10% of the AUM of the main portfolio of a scheme, AMCs have to immediately disclose the same to the investors through SMS and email or letter including details of the portfolio that has not been rebalanced. AMCs will also have to immediately communicate to investors when the portfolio is rebalanced.
Overall, one cannot find fault with this ruling by SEBI as adequate time is being provided to rebalance portfolios with passive breaches which are inevitable, especially when the markets are volatile, like they have been, of late. Also, when analysts and investors compare scheme performances, they really should be comparing apples with apples and not oranges. After all, that is why there was the need to classify mutual fund scheme categories.
Ashok Kumar is the Head of LKW-India. He can be reached at ceolotus@hotmail.com
