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Ignore most fund categories
There are now 36 official categories of mutual funds. You can ignore 32 of them and get by just fine
By Dhirendra Kumar | Aug 24, 2018
As you may have already known, after literally decades of laissez faire, mutual fund regulator SEBI has formalised a system of mutual fund classification. This is a very big step forward in fund regulation, even though it's not 100 percent satisfactory.
The biggest criticism of the new system is that from investors' perspective, it does not really simplify the process of choosing a fund to invest in. There are 2,043 mutual funds in India, and counting all the plans, options and variants, there are possible 9,680 choices. This huge number starts to become manageable if there is some kind of a systematic classification that is applied to these funds. The system that SEBI has now put in place has 36 categories. Are 36 categories easier to begin with than 9,680 schemes? Certainly, they are. However, if you start with close to zero knowledge, which most fund investors do, then even 36 is too much. Let's see how an investor can use the new SEBI system to achieve genuine simplification.
Of course, the basic idea of categories is that if one should divide funds into different buckets based on investment usages and characteristics. With such categorisation, investors can first understand which category meets their investment needs and then evaluate only the funds that fit into that category. However, someone has to do that hard work of classification, and that too on a continuous and consistent basis. In India, Value Research has played the specialist mutual funds research and analysis role for more than two decades.
During this time, we have needed to make plenty of changes to this system. More and more funds of different and new types have been launched. Moreover, fund companies have worked hard to make their funds unclassifiable and thus uncomparable. Added to this is the problem of drift in characteristics. Funds can--and often do--change their investment styles to look better. For example, an investor who invested in a large-cap fund could find that it has gradually drifted towards a higher risk mid-cap fund.
Many of these problems are now getting solved because of the new regulations. There will be an officially stated category which is based on precisely defined investment characteristics. This means that there can be no doubt as to where a fund belongs and who are the peers it should be compared to. It also means that if you invest into a fund of a particular type, there will be a guarantee that it will stay that type, not just in name but also in its operations. What SEBI has done is to bring predictability and regulation to a complex situation. However, the complexity still remains.
Here's a recipe to slice through the thicket of funds and get to you investing goals: ignore almost all the categories. Practically speaking, if you are an individual investor whose financial goals are the normal ones that most people have, then you can easily ignore 32 of these 36. Here's what remains; Multi-Cap for long-term savings, Aggressive Hybrid funds for medium term savings, ELSS funds for tax-savings combined with long-term savings, and short-term debt funds as a superior alternative for bank fixed deposits. That's it.
It will be difficult to do this because SEBI's set of 36 has many categories that have little purpose except to give the sales people complicated stories to tell. While there certainly are funds in many other categories that may have some justification, but if you want a simple to implement plan that also covers all bases and serves all normal investment goals, then you will get along fine. I know that sounds a little extreme, but it will make things extremely simple and still serve all your needs.