Capital market regulator Sebi has mandated that every mutual fund, with a few exceptions, has to rebalance its portfolio if there is a deviation from its Scheme Information Document. But mutual fund portfolios are rebalanced for other reasons too
The Securities and Exchange Board of India (Sebi) had recently directed all mutual funds to comply with its regulations regarding portfolio rebalancing and other such rules by July 1, 2022. If a mutual fund scheme has deviated from its Scheme Information Document (SID) due to circumstances beyond its control, for example, price movement due to market volatility, then it has to rebalance its portfolio according to the SID.
However, there are other situations and factors as well because of which a mutual fund manager has to rebalance a fund’s portfolio. Here are five of the main reasons why a mutual fund’s portfolio is churned:
1. Change In Investment Rating: Sometimes, due to external market forces, the fundamental attributes of an asset changes, which means the mutual fund has to take a relook at investment calls based on the changes and that may lead to a change in the portfolio.
“Credit rating agencies are appointed to rate a company’s bonds and debt funds invest in them accordingly. So, if an underlying bond gets downgraded, there may be a mark to market loss. When a bond is downgraded, it is usually traded at a discount and the yield goes up as a result. If the investment mandate of the debt mutual fund allows it to invest in the newly-rated bond then it can hold it otherwise it has to get out of the investment (which leads to a change in the portfolio),” says Anshul Gupta, co-founder of Wint Wealth, a bond buying platform.
2. Need To Cut Losses: Mutual funds exit or make fresh investments in a particular stock based on fundamentals, corporate governance and many other factors. If the selected stock underperforms, the fund may have to pare its stake or exit completely. For example, several mutual funds exited, trimmed their stake, or refrained from investing in the initial public offerings (IPOs) of new-age technology companies. Click here to know more about mutual funds in Paytm’s IPO.
3. Change In Investment Philosophy: Every mutual fund has a specific investment philosophy. A unique strategy is used to generate returns. If the fund’s investment philosophy changes due to change in fund management style, the fund’s portfolio may see a high portfolio churn rate.
4. New Opportunities: The fund may come across a good investment opportunity within its objectives. It can sell some of its existing holdings and deploy the money in the new opportunity to generate returns for investors. If the fund manager does not take investment calls like these, the fund may lose investment opportunities and may not be able to generate healthy returns.
5.Type Of Fund: You might have invested in funds that have to turn their portfolios frequently depending upon certain indicators. For example, quant mutual funds which use machine learning and algorithms to invest in stocks by factoring in trading volume, news, fundamentals and other factors to invest, may experience a high degree of portfolio rebalancing. This is because it is the inherent nature of these funds to rebalance their portfolios depending upon their specified mandate.