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In order to bring uniformity, SEBI has come out with timelines for rebalancing mutual fund portfolios. The rebalancing period will be applicable if there is a deviation from the mandated asset allocation mentioned in the Scheme Information Document (SID) due to passive breaches. Passive breaches are events not arising due to the actions of fund managers.
Every scheme has its Scheme Information Document (SID) in which details like investment objective, asset allocation, minimum subscription amount, exit and entry load (if any), risk levels, etc are mentioned. The fund manager has to maintain the asset allocation mentioned in the SID. However, sometimes due to volatility in the market, the asset allocation of funds gets changed. So there is a diversion from the mandate which changes the riskiness of the fund. In order to realign the portfolio with its objective and investment mandate, rebalancing needs to be done.
During the Mar-2020 market fall, the asset allocation of many funds changed but it was rebalanced and realigned with its mandated asset allocation. For example, IDBI Hybrid Equity Fund has mentioned in its SID that allocation in equity and equity-related instruments would be between 65% and 80% and that in debt instruments would be between 20% and 35%.
The following table shows the asset allocation of IDBI Hybrid Equity Fund
Source: Ace MF
For IDBI Hybrid Equity Fund, equity and debt allocation was 65% and 33% respectively in Feb 2020 which was within the mandate. But in the next month, markets fell due to Covid-19-led nationwide lockdowns. Because of this, the equity exposure of the fund decreased to 59% which was less than 65%. It is during such times that the portfolio needs to be rebalanced to bring it back within the mandated asset allocation. In the subsequent month, the portfolio was rebalanced and asset allocation as per mandate was achieved.
Let us consider another example – Kotak Equity Hybrid Fund. It also has an investment mandate of 65%-80% in equity and 20%-35% in debt.
Source: Ace MF
For Kotak Equity Hybrid Fund, equity allocation was between 65% and 80% consistently. But its debt allocation was below 20% from Dec 2018 till Apr 2020. In May 2020, portfolio was rebalanced as per investment mandate. Though the portfolio was rebalanced in Apr 2020, it was slightly deviated from its asset allocation mandate for quite a long time.
Earlier different fund houses had rebalancing periods which were not uniform. To bring uniformity regarding rebalancing period, SEBI has come up with a circular which gives guidelines about rebalancing period, what will be the implications if the portfolio is not rebalanced and how will fund houses report deviation in portfolio. These rebalancing norms will be applicable from 1st July 2022.
What is the mandated rebalancing period?
The rebalancing period mandated for all mutual fund schemes except index funds and ETFs is 30 business days. The rebalancing period is not applicable for overnight funds.
Source: SEBI Circular
What will happen if the portfolio is not rebalanced within the mandated timeline?
In case there is a deviation from mandated asset allocation and if the portfolio is not rebalanced within the mandated rebalancing period, justification in writing needs to be placed before investment committee. The justification shall include details of efforts taken to rebalance the portfolio. The investment committee can extend the timeline upto 60 business days from the date of completion of mandated rebalancing period.
If the portfolio is still not rebalanced within the mandated plus extended timelines, the AMC would not be permitted to launch any new scheme till the portfolio is rebalanced. Also, they cannot levy exit load on the investors exiting such schemes.
What cost implications may arise due to rebalancing?
Due to this guideline if a fund manager has recently rebalanced their portfolio it will add to their cost due to frequent rebalancing as more number of rebalancing leads to higher expenses. To tackle this problem, the fund Manager usually keeps a higher tolerance level (5% - 10%) as higher tolerance level means the frequency of rebalancing will be lower and hence the cost of rebalancing will also be lower.
How will fund houses report deviation in portfolio?
AMCs are required to report deviation to Trustees at each stage. If the AUM of deviated portfolio is more than 10% of the AUM of the main portfolio, AMCs will have to immediately disclose the same to the investors through SMS and e-mail/ letter including details of portfolio not rebalanced. AMCs will also have to immediately communicate to investors through SMS and e-mail/ letter when the portfolio is rebalanced. The Subject line of these email should be clearly stating the ‘breach of’ or ‘deviation’ from mandated asset allocation.
From when will be the rebalancing norms applicable?
The rebalancing norms are applicable to the main portfolio only and not to segregated portfolios. These will be applicable from 1st July 2022.
How will SEBI’s move impact mutual fund investors?
This is a positive move for mutual fund investors. It will allow investors to stay on right track to achieve financial goals with mutual funds that aligns with their risk profile. They will not have to worry if their mutual fund scheme is following the asset allocation mentioned in the SID.
For example, multi cap category funds are mandated to invest a minimum 25% each in large, mid and small caps. Suppose if mid and small cap stocks rally and allocation of large caps fall below 25%. SEBI’s guidelines on rebalancing will ensure that fund managers adhere to the asset allocation mandate mentioned in the SID and rebalance the portfolio accordingly.
Due to volatile market, allocations of some multicap funds have deviated
Data as on 30th Apr 2022
Source: Ace MF
Most fund managers ensure that allocation aligns with the investment objective. However, the time for rebalancing varies from one fund house to another in case there is a deviation in portfolio. SEBI’s rebalancing guidelines will bring uniformity in rebalancing time for all fund houses which will keep the portfolio in line with investors’ risk profile.
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