2.1 Equity Schemes
Equity schemes invest predominantly in equity and equity-related instruments. SEBI's October 2017 circular on mutual fund categorization standardized equity scheme definitions, ensuring uniformity across the industry and preventing scheme name confusion.
SEBI Categorization Framework
SEBI mandated that mutual fund schemes be clearly categorized based on their asset allocation. For equity schemes, the minimum equity exposure must be specified in the Scheme Information Document (SID).
SEBI circular dated October 6, 2017 established 36 categories for mutual fund schemes, including 11 categories for equity schemes. Each AMC can have only one scheme per category (with limited exceptions). This prevented multiple similar schemes and reduced investor confusion.
Equity Scheme Categories
| Category | Asset Allocation | Benchmark/Definition |
|---|---|---|
| Large Cap Fund | Min 80% in large cap stocks | 1st-100th company by market cap |
| Mid Cap Fund | Min 65% in mid cap stocks | 101st-250th company by market cap |
| Small Cap Fund | Min 65% in small cap stocks | 251st company onwards |
| Large & Mid Cap | Min 35% each in large and mid cap | Combination approach |
| Multi Cap Fund | Min 25% each in large, mid, small cap | Diversified across market caps |
| Flexi Cap Fund | Min 65% in equity | No restriction on market cap allocation |
| ELSS | Min 80% in equity | Tax saving with 3-year lock-in |
| Dividend Yield | Min 65% in dividend yielding stocks | Income-focused equity |
| Value Fund | Min 65% in equity following value strategy | Value investing approach |
| Contra Fund | Min 65% in equity following contrarian strategy | Contrarian investing approach |
| Focused Fund | Min 65% in equity (max 30 stocks) | Concentrated portfolio |
Sectoral/Thematic Funds
These funds invest in specific sectors or themes:
- Sectoral Funds: Minimum 80% investment in a particular sector (e.g., Banking, IT, Pharma)
- Thematic Funds: Minimum 80% investment in a particular theme (e.g., ESG, Infrastructure, Consumption)
- Index Funds: Minimum 95% investment in securities of a particular index
- ETFs: Exchange-traded units tracking an index
SEBI amended Multi Cap Fund requirements in September 2020, mandating minimum 25% allocation each to large, mid, and small cap stocks (earlier it was only 65% minimum in equity with no sub-limits). This caused significant portfolio rebalancing across the industry.
ELSS - Tax Saving Schemes
2.2 Debt Schemes
Debt schemes invest in fixed-income securities such as government bonds, corporate bonds, money market instruments, and other debt securities. SEBI categorization standardized 16 debt scheme categories based on duration and credit quality.
Debt Scheme Categories
| Category | Macaulay Duration/Investment | Risk Profile |
|---|---|---|
| Overnight Fund | Overnight securities (1 day maturity) | Very Low |
| Liquid Fund | Up to 91 days | Low |
| Ultra Short Duration | 3-6 months | Low to Moderate |
| Low Duration | 6-12 months | Low to Moderate |
| Money Market | Up to 1 year (money market instruments) | Low to Moderate |
| Short Duration | 1-3 years | Moderate |
| Medium Duration | 3-4 years | Moderate |
| Medium to Long Duration | 4-7 years | Moderate to High |
| Long Duration | >7 years | High |
| Dynamic Bond | Investment across duration | Variable |
| Corporate Bond Fund | Min 80% in AA+ and above corporate bonds | Moderate |
| Credit Risk Fund | Min 65% in below AA rated bonds | High |
| Banking & PSU Fund | Min 80% in bank/PSU debt | Low to Moderate |
| Gilt Fund | Min 80% in G-Secs across maturities | Moderate |
| Gilt Fund with 10-year duration | Min 80% in G-Secs (10-year constant duration) | High |
| Floater Fund | Min 65% in floating rate instruments | Low to Moderate |
Credit Risk in Debt Funds
Credit risk management is crucial for debt funds. Key considerations include:
- Credit Rating: Investment grade (AAA to BBB-) vs. non-investment grade
- Concentration Risk: Exposure limits to single issuer (group limits)
- Sector Exposure: NBFC, real estate, infrastructure sector limits
- Side Pocketing: Segregation of distressed assets (SEBI circular December 2018)
Six Franklin Templeton debt schemes were wound up in April 2020 due to redemption pressure and illiquidity in underlying bonds. Key lessons: (1) Credit risk funds carry significant default risk, (2) Liquidity management is critical, (3) SEBI enhanced disclosure norms post-crisis. The Supreme Court upheld unitholder consent requirement for winding up.
Side Pocketing Framework
SEBI introduced side pocketing in December 2018 to protect investors from credit events:
- Trigger Event: When a debt instrument is downgraded to below investment grade
- Segregation: Affected security moved to a separate "segregated portfolio"
- Unit Creation: Separate units issued for segregated portfolio
- Recovery: Any recovery distributed to holders of segregated units
- NAV Impact: Main portfolio NAV not impacted by subsequent write-offs
2.3 Hybrid and Balanced Funds
Hybrid schemes invest in a mix of equity and debt instruments, offering a balanced risk-return profile. SEBI categorization established 7 distinct hybrid categories based on equity-debt allocation ranges.
Hybrid Scheme Categories
| Category | Equity Allocation | Debt Allocation | Character |
|---|---|---|---|
| Conservative Hybrid | 10-25% | 75-90% | Debt-oriented |
| Balanced Hybrid | 40-60% | 40-60% | True balanced (no arbitrage) |
| Aggressive Hybrid | 65-80% | 20-35% | Equity-oriented |
| Dynamic Asset Allocation | 0-100% | 0-100% | Managed dynamically |
| Multi Asset Allocation | Min 10% each in 3 asset classes | Including gold/real estate | Diversified |
| Arbitrage Fund | Min 65% in equity (arbitrage) | Arbitrage positions | Low risk equity taxation |
| Equity Savings | Min 65% equity (including hedged) | Min 10% debt | Partially hedged |
Tax Implications
Tax treatment depends on equity allocation:
Equity-Oriented (>65% equity): LTCG (>1 year) taxed at 12.5% above Rs. 1.25 lakh; STCG at 20%.
Debt-Oriented (<65% equity): Gains taxed at applicable income tax slab rates regardless of holding period (post-2023 amendment).
Arbitrage Funds
Arbitrage funds exploit price differences between cash and derivatives markets:
- Buy in cash market, sell futures simultaneously
- Lock in the spread (arbitrage profit)
- Minimum 65% in equity arbitrage positions
- Taxed as equity fund despite low-risk profile
- Returns typically 5-7% p.a. (similar to liquid funds)
2.4 Fund of Funds
Fund of Funds (FoF) are mutual fund schemes that invest in units of other mutual fund schemes rather than directly in securities. FoFs provide diversification across fund managers and investment styles.
Types of Fund of Funds
- Domestic FoF: Invests in other domestic mutual fund schemes
- International FoF: Invests in overseas mutual funds/ETFs
- Gold FoF: Invests in Gold ETF units
- Multi-Manager FoF: Invests across multiple fund houses
- Asset Allocation FoF: Invests in equity and debt schemes based on allocation model
Regulatory Framework
Key regulations governing FoFs:
- Minimum 95%: Investment in underlying schemes
- Expense Ratio: Total expense (FoF + underlying) is subject to overall limits
- No Double Counting: Underlying scheme expenses to be excluded from FoF TER
- International FoF: Subject to overseas investment limits (currently $7 billion industry-wide)
SEBI/RBI have imposed aggregate limits on overseas investments by mutual funds. In February 2022, fresh investments in international FoFs were temporarily halted when the $7 billion limit was breached. Several FoFs had to stop accepting fresh investments until limits were enhanced.
Tax Treatment of FoFs
FoFs are treated as debt funds for tax purposes (even if underlying is equity), unless specifically structured as equity FoF with 90%+ in equity schemes.
2.5 Scheme Information Document (SID)
The Scheme Information Document is the primary disclosure document for mutual fund schemes. It contains all material information that an investor needs to make an informed investment decision.
SID Components
As per SEBI regulations, SID must contain:
| Section | Contents |
|---|---|
| Section I - Introduction | Fund details, sponsor, trustee, AMC, custodian |
| Section II - Information about Scheme | Investment objective, asset allocation, risk factors |
| Section III - Units and Offer | NFO details, ongoing offer, cut-off times, NAV |
| Section IV - Fees and Expenses | Loads, TER, transaction charges |
| Section V - Rights of Unitholders | Investor rights, grievance redressal |
| Section VI - Penalties | Regulatory actions and penalties history |
Statement of Additional Information (SAI)
SAI contains additional statutory information common to all schemes:
- Constitution of mutual fund
- Sponsor, trustee, and AMC details
- Condensed financial information
- Tax implications
- Legal and general information
Key Information Memorandum (KIM)
When reviewing SID/SAI: (1) Verify scheme categorization compliance, (2) Check expense ratio within limits, (3) Confirm risk-o-meter rating, (4) Review investment restrictions, (5) Ensure complaint statistics are updated, (6) Verify regulatory history disclosure.
Risk-O-Meter
SEBI mandated risk-o-meter disclosure from January 2021:
- Six risk levels: Low, Low to Moderate, Moderate, Moderately High, High, Very High
- Must be displayed in all scheme documents and communications
- Monthly review of risk level required
- Change in risk level to be communicated to investors
Key Takeaways
- SEBI Categorization: 36 standardized categories - one scheme per category per AMC
- Equity Schemes: 11 categories based on market cap and investment strategy
- Debt Schemes: 16 categories based on duration and credit quality
- Hybrid Schemes: 7 categories based on equity-debt allocation mix
- Tax Treatment: >65% equity = equity taxation; <65% = debt taxation
- SID Compliance: Complete disclosure of scheme features, risks, and expenses mandatory