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On its way: a radical simplification of mutual funds

SEBI wants that each fund company should have only one fund of each type. This could be a great thing for the Indian investor

On its way: a radical simplification of mutual funds

There's some talk that mutual fund regulator SEBI is planning to limit the number of funds that mutual fund companies can operate. If true, this is a brilliant idea that should be implemented quickly. This one change alone would go a long way in ensuring that mutual fund investors will choose a fund that is suitable for them, and will stick to it. It would be reform that is entirely positive, with no downside whatsoever.

Each company will be allowed only one fund of each type. The idea is to reduce the complexity of the choices that investors have to make. Currently, there are over 2500 distinct funds, and several plans under most of them. Even if one looks at broad categories like equity, debt or hybrid, there are hundreds of funds in each. There is no way that an investors can make sense of this huge number and choose after understanding what he or she is investing in.

SEBI is said to be targeting this complexity at the level of each AMC, where each one should have just one or two funds in each category. I guess the final degree of simplification would depend on how 'category' defined, but according to reports, there will be eight debt fund categories and six for equity funds. While fixed income funds are mostly of interest to corporate and professional investors who are better equipped to understand complexity, the retail-focussed equity funds will be much easier to understand for investors. The equity categories that SEBI is said to be planning are large cap, mid-cap, micro-cap, ELSS, balanced funds, arbitrage funds and concentrated funds.

The biggest positive impact will come from the categories being easier to understand for investors. In terms of risk vs potential returns, each of these can be easily mapped to a particular need. A potential investor can easily choose which one is most suitable. Beyond simply choosing a category, the real payoff will come in being able to unambiguously compare different funds. Today, no two fund companies define their funds in exactly the same way. As a result, salesmen can always avoid any comparison with another fund companies' fund that might be doing better. The salesperson can always spin some tale about how the other fund is of a different type and has a different goal or has some hidden weakness.

With each fund unambiguously placed in a statutorily defined category, this kind of obfuscation will become impossible. If you are running a large-cap fund, then it must be comparable with every other large cap fund that exists. Obviously, fund marketers are going to hate this. The very reason that there are such a huge number of funds in India is that they have mostly been sold on the basis of novel features. Like any consumer product from soaps to phones to cars, marketers try to guide customers into thinking about features (real or imaginary) and away from evaluating inherent quality. In investment products, this is really bad for the customers.

De-featurisation and commodisation will make funds comparable and help investors make the right choice. In fact, this is a major part of what Value Research has been doing all these years. Classifying funds into categories and comparing like with like helps investors discover the truth about their investments.

SEBI's move will give this categorisation regulatory authority and make comparison unambiguous. I'm sure there will be a lot of push back from the fund industry on how this will reduce choice and thus have a negative impact, but don't believe that for a moment. There are 40 fund companies in India and if a large proportion have a fund in each category, that's plenty of choice. Moreover, it's the right kind of choice, where all funds are comparable and the potential investor can focus on which are the better ones.

If SEBI pushes through this plan for radical simplification, it will be the best thing to happen to the Indian fund investor.