Renaming Dividend Plan & Addition in Risk-o-Meter – Here’s What SEBI’s New Circulars Mean

October 2020

4 min read

 

Market regulator SEBI has been relentlessly working to enhance mutual funds in order to make them more efficient for investors. In this pursuit, the latest step taken by SEBI addresses two major aspects: Dividend plans of mutual funds and showcasing the risk for each fund. SEBI issued two circulars on 5th October 2020 addressing these two aspects. Let’s understand this in more detail and see how it impacts you as an investor.

Renaming Dividend Plans

From 1st April 2020, all the dividend plans of mutual fund schemes will be renamed as per the guidelines given by SEBI. The change will be made as follows:

1. Dividend Payout plan will now be renamed as “Payout of Income Distribution cum capital withdrawal option”
2. Dividend Reinvestment plan will be called “Reinvestment of Income Distribution cum capital withdrawal option”
3. Dividend Transfer plan will be now “Transfer of Income Distribution cum capital withdrawal option”

At the outset, this may look like a small change but it has a bigger impact. Here’s why:

Dividend plans are used by the investors to generate regular income from investments at a defined frequency. However, there was a misbelief that the dividend is form of profit and is paid out of profit. In most cases, dividend is paid out of profit and capital because it is practically impossible to pay the dividend from profit when markets are volatile and there are no profits. However, till now, there was no clear bifurcation between the profit and capital part of dividend paid. Hence, investors were kept in the dark and were always under the impression that dividend is part of their profit.

With the new rule, Fund houses have to clearly divide the dividend amount in two parts: Income distribution (Profit) and Capital Distribution (actual invested amount). This will be disclosed in the Consolidated Account Statements.

Investica’s View on Renaming Dividend Plans

At Investica, we always recommended investors to stay away from dividend plans due to unfavourable taxation and lack of clarity in dividend paid by the fund houses. With the new rule, Dividend plans will become more transparent and investors will be able to get understanding of how much of the total dividend is actually paid from the profits made by the funds. This move may also ultimately lead to Investors moving to Growth plan from Dividend plan after knowing the breakup of profit and capital in dividend amount. We welcome this move by SEBI as it empowers investors to take the informed decision on their investments.

Addition in Risk-o-meter

Risk-o-meter is simply an indicator of mutual fund risk exposure. From January 2021, the mutual fund Risk-o-meter will have 6 types of risks:

1. Low Risk
2. Low to Moderate Risk
3. Moderate Risk
4. Moderately High Risk
5. High Risk
6. Very High Risk

This is how a Risk-o-meter will look like:

Not only this but SEBI has also given guidelines on how to arrive at the risk in this Risk-o-meter for each scheme. Here’s a brief summary of these guidelines:

For Debt Mutual Funds, the risk will be calculated based on 3 factors:

Credit Risk – In this Each credit rating has been given one value. For example, G Sec and AAA Rated papers have a value of 1 and BBB- rated papers have a value of 10. Indicating that as the value increases from 1 to 10 the risk also increases.

Interest Rate Risk – Interest rate risk is arrived at by assigning values to Macaulay duration of the portfolio. Duration of less than equal to 0.5 years has a value of 1 and Duration of more than 4 years has a value of 6. The Meaning of this is similar to credit risk as we go from 1 to 6 the interest rate risk increases.

Liquidity Risk – Liquidity Risk is measured by assessing the credit quality of underlying papers. For example, G Sec and AAA rated PSU papers have a value of 1 and BBB- rated papers have a value of 11 depicting increase in risk with it’s value.

Similarly, for Equity Mutual Funds, the risk is calculated with 3 factors:

Market Capitalisation – A value will be assigned to large cap , mid cap and small stocks. Large cap will have a value of 5 and small cap will have a value of 9. This shows increase in in risk when we move from large cap to small cap.

Volatility – This is calculated based on daily volatility of the stock price based on past 2 years of price of security. If the volatility is less than or equal to 1% it is less risky but if it is more than 1% it is riskier.

Liquidity – Impact cost is considered as a measure to calculate liquidity. Higher impact cost means higher volatility and vice versa.

Investica’s view on Addition in Risk-o-meter

In the earlier version of Risk-o-meter, the risk was getting defined based Mutual fund category and not individual fund. The new rules will change this and each fund will get it’s own Risk-o-meter which will get updated every month. This will give more accurate representation of risk exposure in each fund. Investors can now refer to Fund Risk-o-meter to get understanding of each fund’s risk exposure and to shortlist funds that match their own risk profile. Again, this step will also make the mutual funds more transparent and investor friendly.

Want more clarity on this? Get in touch with our Support team and understand the new changes in more detail.