Sebi proposes changes in categorization and rationalization of mutual fund schemes

Markets regulator Sebi on Friday proposed to review the categorisation of mutual fund schemes to improve clarity, introduce new schemes and to address the issue of overlap in portfolios of schemes.

The proposal came after Sebi noted there was a significant overlap of portfolios. It was therefore felt necessary to introduce clear limits to the industry to avoid schemes with similar portfolios. The market regulator has asked for comments/suggestions to be submitted latest by August 8.

Also Read | Sebi proposes to bring uniformity in valuation process of gold and silver ETFs

In its consultation paper, Sebi suggested that mutual funds should be permitted to offer both value and contra funds, subject to the condition that no more than 50% of the schemes' portfolios shall overlap at any point in time.

The overlap condition should be monitored at the time of New Fund Offer (NFO) deployment and subsequently on a semi-annual basis using month-end portfolios. In case of more than permitted overlap, AMC shall rebalance the portfolios within 30 business days. An extension of up to an additional 30 business days may be obtained from the Investment Committee (IC) of the AMC.

"If the deviation persists beyond this period, investors of both the schemes shall be given an exit option without any exit load," Sebi has proposed.

Equity funds
In case of sectoral and thematic funds, for any scheme offering in this category schemes, Mutual Funds shall ensure that no more than 50% of the schemes portfolios would overlap with other equity schemes in sectoral/thematic equity schemes categories except for large cap schemes.

And existing thematic /sectoral funds shall ensure compliance w.r.t portfolio overlap within one year from the date of this circular.

The regulator also proposed that Mutual Funds shall be permitted to invest residual portion in equity, debt (including money market instruments), gold and silver (instruments as permitted by SEBI), REITs and InvITs, subject to the ceilings laid out in MF regulations w.r.t the respective asset class, in the equity category schemes.

Note, the residual portion above refers to the remaining part of the scheme’s assets that is not invested in the primary asset class as defined by the scheme’s category. It provides flexibility to the fund manager to deploy this portion in other permissible asset classes, to manage liquidity and risk.

Debt funds
Sebi also proposed changes in the nomenclature of debt schemes to enhance investor understanding. It proposed that the term 'Duration' be replaced with 'Term' for better clarity.

Additionally, the nomenclature of the "Low Duration Fund" to be changed to "Ultra Short to Short Term Fund" to better reflect the investment objective and improving investor clarity and the name of the debt category scheme should include duration of the fund such as overnight fund (1 Day) or medium term fund (3 to 4 years)

The regulator further proposed that mutual funds should be allowed to launch sectoral debt fund subject to ensuring that no more than 60% of the portfolio in a sectoral debt scheme overlaps with any other sectoral debt scheme/debt category scheme, while also ensuring sufficient availability of investment-grade paper in the chosen sectors, and exempting such schemes from the sectoral exposure limits under Clause 12.9.1 of the Master Circular.

Mutual funds should be allowed to invest the residual portion of their debt category schemes in REITs and InvITs except for the schemes with shorter duration (e.g. Overnight Fund, Liquid Fund, Ultra-Short Duration Fund, Low Duration Fund, and Money Market Fund) subject to regulatory limits for this asset class.

Also Read | NFO Insight: Capitalmind Mutual Fund’s flexi cap fund opens for subscription. Will it help to manage current market volatility?

Hybrid funds
In the case of hybrid funds, the arbitrage fund category scheme should be allowed to take exposure in debt instruments only in government securities with a maturity of less than one year and in repos backed by government bonds. The net equity exposure and arbitrage exposure should be mandated between 15%-40% in the equity saving scheme category

Mutual funds should be allowed to invest the residual portion of their hybrid category schemes in REITs and InvITs except for Dynamic Asset Allocation and Arbitrage Fund subject to regulatory limits for this asset class.

Solution oriented funds
In the case of solution oriented funds, mutual funds should be allowed to offer different types of schemes in the solution oriented category offering a different mix of equity and debt portion and the asset allocation stated should be appropriate for the solution oriented category scheme.

Mutual funds should be allowed to invest the residual portion of their solution category schemes in REITs and InvITs except for the Retirement Fund – Hybrid and Children’s Fund - Hybrid, subject to regulatory limits for this asset class.

Other schemes
In the case of other schemes, the market regulator informed that to address risk of scheme proliferation in this category, a framework in consultation with AMFI will be issued separately.

Mutual funds should be allowed to offer solution oriented life cycle fund of funds, with a lock in, for other specific goals such as housing, marriage etc and should provide specific goals with rationale.

Mutual funds should be allowed to offer solutions oriented life cycle fund of funds with different lock in periods such as 3 years, 5 years or 10 years and should provide lock in period with rationale.

A solution oriented open ended fund of funds with a target date investing in underlying scheme as per a defined structure.

Life Cycle FoFs may invest in underlying debt category schemes except for All Seasons Bond Fund and in all hybrid category schemes except for Aggressive Hybrid Fund, Dynamic Asset Allocation, Multi Asset Allocation Fund.

Also Read | Eternal and RIL among stocks that Kotak Mutual Fund bought and sold in June

Launching additional scheme
AMC on its discretion may launch an additional scheme in the existing scheme categories listed above subject to some conditions such as the existing scheme in the category should have completed more than 5 years, existing scheme shall have an AUM of more than Rs 50,000 crore, additional scheme shall have similar investment objective, investment strategies and asset allocation, broad features as the existing scheme and a separate scheme information document shall be released by the AMC.

It further mentions that upon the launch of additional scheme, existing scheme shall stop accepting subscriptions, AMC may appoint a separate fund manager for the additional scheme, additional scheme shall follow same disclosures related to performance, expense ratio and other regulatory requirement as the existing scheme, the total expense ratio of the additional scheme shall be capped at the TER as last disclosed by the existing scheme on the date of NFO of additional scheme.

The other condition includes that additional scheme shall use the similar nomenclature as existing scheme in order to maintain true to label status and avoid confusion in the mind of the investors e.g. Large Cap Fund (existing scheme or Series 1) and Large Cap Fund (series 2 or additional series)

And lastly AMC may merge an existing scheme with an additional scheme if there is a significant decline in the AUM of the existing scheme, making it operationally unfeasible or necessitating transitional adjustments for effective management. AMC shall ensure that no more than 2 schemes exist in the same category at any point in time.