Low Style Consistency in Large-Cap and Mid-/Small-Cap Fund Categories

Style plays an important role in an investor’s asset allocation decisions. In the SPIVA India Mid-Year 2018 Scorecard, one can notice the low style consistency, especially in the Indian Equity Large-Cap and Indian Equity Mid-/Small-Cap categories. The Securities and Exchange Board of India (SEBI) circular dated Oct. 6, 2017, mandated the following important directives for the Mutual Fund Industry.[1]

  1. It defined five equity size categories ranked by total market capitalization:
    1. Large Cap (80% of assets invested in equity; ranked from 1-100)
    2. Mid Cap (65% of assets invested in equity; ranked from 101-250)
    3. Small Cap (65% of assets invested in equity; ranked from 251-500)
    4. Multi Cap (65% of assets invested in equity)
    5. Large and Mid Cap (at least 35% of assets invested in large caps and at least 35% assets in mid caps)
  2. It obligated mutual funds to manage only one product offering in each category. Therefore, a fund house with multiple offerings in the same category would have to either merge, liquidate, or change the style of its existing schemes to the same category if necessary.

These mandates have had important implications for the mutual fund industry and investors. The fund houses had to not only align their portfolios as per the size definitions laid out, but they also had to ensure a unique offering in each size category. For example, as per the second rule, a mutual fund house offering two large-cap schemes would have to either liquidate one scheme, merge it into another scheme, or change the style of one of the offerings.

The aforementioned implications may have been one of the reasons for the relatively lower style consistency over the one-year period ending in June 2018, as funds would have initiated the process to align their product offerings with SEBI’s guidelines.

Exhibit 1: Style Consistency in the Indian Equity Large-Cap and Mid-/Small-Cap Categories
FUND CATEGORY INDIAN EQUITY LARGE-CAP INDIAN EQUITY MID-/SMALL-CAP
Total Funds Available in June 2017 66 45
Style-Consistent Funds 28 33
Style-Inconsistent Funds 38 12
Category Style Consistency (%) 42.4 73.3

Source: S&P Dow Jones Indices LLC, Morningstar, and Association of Mutual Funds in India. Data from June 30, 2017, to June 30, 2018. Past performance is no guarantee of future results. Table is provided for illustrative purposes.

For example, in the case of the 66 large-cap funds available at the end of June 2017,[2] three failed to survive the one-year investment horizon. During this period, a total of nine funds moved to the newly defined focused fund category, eight moved to the large- and mid-cap fund category, and nine moved to the multi-cap fund category (see Exhibit 2). This resulted in an overall style consistency of 42.4% for Indian Equity Large-Cap funds over the one-year period ending in June 2018 (see Exhibit 1).

For the Indian Equity Mid-/Small-Cap fund category, the style consistency was higher than for large caps, at 73.3%. Few funds moved to the new large- and mid-cap, multi-cap, and focused fund categories.

Exhibit 2: Breakdown of Style Inconsistency in Funds
MORNINGSTAR CATEGORIES INDIAN EQUITY LARGE-CAP INDIAN EQUITY MID-/SMALL-CAP
Total Style Inconsistent Funds 38 12
Dead Funds 3
India Fund Aggressive Allocation 1
India Fund Children 1
India Fund Contra 1
India Fund Dynamic Asset Allocation 3
India Fund Equity – Other 3 1
India Fund Focused Fund 9 2
India Fund Large & Mid-Cap 8 3
India Fund Large-Cap NA
India Fund Mid-Cap NA
India Fund Multi-Cap 9 2
India Fund Small-Cap NA
India Fund Value 1 3

Source: S&P Dow Jones Indices LLC, Morningstar, and Association of Mutual Funds in India. Data as of June 30, 2018. Past performance is no guarantee of future results. Table is provided for illustrative purposes.

A change in style during the investment tenure may potentially affect the risk/return characteristics of a portfolio. For example, a multi-cap fund offering participation to small-cap stocks has the potential to augment returns but at a higher risk and potential drawdown in comparison with a large-cap fund, which may not have been an investor’s initial expectation at the time of investment.

[1]   Data from SEBI. https://www.sebi.gov.in/legal/circulars/oct-2017/categorization-and-rationalization-of-mutual-fund-schemes_36199.html

[2]   Data as per Morningstar category classifications.

The posts on this blog are opinions, not advice. Please read our disclaimers.

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