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How would fund reclassification impact existing investors?

Dhirendra Kumar talks about the negative impact of the new reclassification system

How would fund reclassification impact existing investors? Do you see any negative impact?
- Ramakrishnan

Yes, I see quite a few impact and some of them will be negative. Some funds will merge with others. Some fund companies have many similar kinds of fund and that was the reason why SEBI wanted to standardise the classification. So, one fund company having two balanced funds, will be forced to merge and it will become a very big fund. There is a problem with very large funds, it is called winner's curse. You do well, you get more money and once you get more money, it gets hard to deploy it further. It could be particularly counter productive on certain strategies specially for small-cap funds and mid-cap funds. The reason why these funds did well when they were Rs 500 crore to Rs1,000 crore fund is that they built a portfolio, of say 25 stocks, it had to buy Rs 20 crore of worth each stock to diversify. And buying a small company stock worth Rs 20 crore is not hard. But as you get bigger, and if you have to look for 40 such stocks, it becomes difficult. The portfolio may become a long tail and then they might have to worry about liquidity.

But this could be an advantage in many cases. For example, large-cap funds will not have this problem. They will still build a portfolio of 40 stocks and the portfolio could be very big, say Rs 50,000 to Rs 70,000 crore. It can still be managed as the big companies have that kind of liquidity. You can sell a position of Rs 100 to Rs 200 crore any day without making any meaningful impact. And that will also trigger the economies of scale.

So, small-cap funds, mid-cap funds and some of the balanced funds would be something to watch out for.

Other thing would be a disadvantage. Some funds would change the context. You bought a mid-cap fund and now it will change, say, to a multi-cap fund. Because the fund manager chose that it will qualify better as this one. And you want a mid-cap fund, so you will be forced to sell and move elsewhere. That can trigger short-term capital gains. So, you will have to do some planning. Either settle with that fund till it gets older and stop your new money pouring into it. But I don't see too many changes of that kind. These are two things to watch out for.

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