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3 Things To Do When A Mutual Fund Scheme Changes Fundamental Attributes - Outside View by PersonalFN
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3 Things To Do When A Mutual Fund Scheme Changes Fundamental Attributes
May 18, 2017

It is common sense to revisit basics when a/the circumstance/s has changed and you think you've taken a wrong turn.

Imagine this...

Your friend referred a doctor, who enjoyed a reputation for being one of the sharpest minds in the industry, to you. Lately, however, you noticed he's devoting less time to his regular patients, including you, and busier with more critical cases. Many a times when you visit him for health concerns, you don't even get a chance to speak with him; and, his support staff is obliged to "entertain" you.

At some point, wouldn't you reconsider continuing to subscribe to this doctor? Wouldn't you ask yourself why, in the first place, you started to consult this renowned medical professional?

This is defined as' revisiting the basics', and you may not agree, but this is an important exercise to ensure you are on the best path for your wellbeing.

If this instance makes sense to you, then revisit basics when it comes to your mutual funds too! After all, fund managers are no less than your financial surgeons. They make sure your mutual fund investments are in good health.

Of late, it's been experienced that, many mutual fund schemes have changed their fundamental attributes.

A change in primary attributes may rarely necessitate any action.

For example, after the regulator allowed mutual funds to invest in Real Estate Investment Trusts (REITs), certain schemes altered the asset allocation mandate, such that it specifies an allocation to REITs as well.

However, this amendment just provides an enabling power to the fund and may not necessarily translate into investments in REITs. So avoid jumping to conclusions.

A change in the investment mandate is a fundamental shift, but it would be imprudent to redeem your mutual fund schemes, thinking your fund manager will exercise the option right away, and this could hamper your investment returns.

First observe, whether the change in the primary attributes of a scheme is being introduced to offer more flexibility or will it eventually affect the functioning of the mutual fund scheme.

For instance, if the investment mandate is moving from an aggressive to conservative, then maybe, you need revisit the fund as it could have a bearing on your asset allocation, impede the investment objective, and may be out-of-sync with your risk profile while you endeavour to achieve certain financial goals. Alternatively, you can always seek the assistance of a Certified Financial Guardian in such cases for this purpose.

However, some changes in the working of mutual fund schemes are inevitable and mostly occur because of technical factors. For example, a midcap fund may suddenly start carrying a large-cap dominated portfolio. This event is possible if the valuations in the mid and small cap segment are expensive.

Under such circumstances check out if the fund manager alters the allocation between midcaps and large-caps within the mandated allocation limits. Keep cool if you find the change is within the mandated allocation limits. But if allocations have gone askew and continue to remain, then that should be a cause of concern.

Sometimes, micro and small-cap funds deliver stunning returns when they are smaller in size. But riding this success, when their Asset Under Management (AUM) swells so much that they start facing problems in the efficient deployment of available corpus, that's the time when problem occurs -eventually, they tend to lose focus and start delivering a below par performance.

On the other hand, when the mutual fund houses stop accepting new investments in a scheme, soon realizing the scheme's AUM has grown beyond a certain capacity to manage it efficiently; you as an existing investor would stand to benefit as far as the risk-return trade-off goes.

Cases wherein the AUM is the primary driver for the change in the fundamental attributes, you must carefully notice how the fund house is responding to that, before taking any action in haste.

At times, you will observe mutual fund schemes lowered the number of stocks in their portfolios. Adopt the 'wait-and-watch' attitude and don't rush to conclude that a scheme has become riskier.

You would appreciate that beyond a point, diversification adds no value. So if your portfolio retreats its exposure from 55 stocks to 40 stocks, it doesn't necessarily mean the fund manager is playing Russian roulette. Often, in the absence of investment opportunities or in the down trending markets, having more stocks in a portfolio can work against your financial wellbeing. Although there's no magic number, various studies show that any number between 20 and 30 is good enough to provide you adequate diversification.

Therefore, closely monitor the volatility and the performance of the scheme post changes, before you make up your mind to redeem your investments.

Sometimes in the pursuit of earning high returns or alpha, fund managers take undue risks. For example in case of a debt mutual fund scheme, they could be investing heavily in inferior quality credit instruments. Be careful of that, because the primary objective of any debt oriented scheme is rarely to maximise gains and hence, the quality of the debt papers held in the portfolio is important.

In a nutshell...

Therefore, if you notice any change in the fundamental attributes of a mutual fund scheme, do revisit the Scheme Information Document (SID) to find out if the modifications are consistent with the original mandate.

When there's a fundamental change in the scheme, it is rarely that you will need to take any immediate action. And, exiting a scheme in a hurry can sometime prove to be a really bad choice.

So what should you ideally do under such circumstances? Well, here are three tips that help:

  1. Do nothing beyond taking a note of the changes, at least initially
  2. Try to analyse the impact over time
  3. Take action, only if necessary

It's more about psychology than about fundamentals alone...

Personal finance, many of you would agree is behavioural. Many a times, actions or decisions are guided by emotions rather than prudence.

Revisiting the fundamentals can be worthy exercise, only avoid myopic conclusions, or you may take a wrong turn.

Think about it...and apply logically in the interest of your long-term financial wellbeing.

To help you achieve your financial goals that are 7-8 year away from now, PersonalFN based on a rare investment strategy presents "The Strategic Funds Portfolio For 2025". We strongly recommend you to opt for this mutual fund research service and avail a whopping discount of over 50%. No yearly subscription, no recurring fees. Get instant access to this exclusive report.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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