Ready Reckoner- New Products Introduced by SEBI

The mutual fund industry in India has witnessed a phenomenal surge in the past decade, with assets under management (AUM) growing over seven times to Rs 61.2 lakh crore in June 2024 from Rs 8.3 lakh crore in December 2013. Passive Funds’ AUM has grown to Rs 10.2 lakh Crore with 17% of the market share.

A few months ago, SEBI introduced two new frameworks for Mutual Funds: Mutual Fund Lite (MF Lite) and Investment Strategies.

While MF Lite aims to simplify the rules for passively managed mutual funds in India, Investment Strategies comprises an entirely new asset class.

These changes are a positive move for companies looking to enter this space and, importantly, for investors.

How exactly? Let’s deep-dive.

To start..What are passive funds?

Passive funds are investment vehicles that aim to replicate the performance of a specific market index, such as the Sensex or the Nifty 50. Unlike actively managed funds, which aim to outperform the market, passive funds simply seek to match the performance of their underlying index. Passive funds can be broken down into two sub-categories:

• Index Funds: These are mutual funds that track a specific market index, such as the Nifty mid-cap index.
• Exchange-Traded Funds (ETFs): ETFs are similar to index funds but trade on stock exchanges like individual stocks.

The New MF Lite framework is aimed at fund houses that solely launch passively managed schemes. The raison d’etre for this move by SEBI is that the present regulatory framework for MFs is uniformly applicable for all schemes and does not differentiate regarding the applicability of provisions relating to entry barriers — net worth, track record, profitability, etc, as well as other compliance requirements for entities who may be desirous of launching only passive funds.

The framework will feature relaxed requirements around –

• sponsor eligibility,
• including net worth,
• track record,
• profitability
• changes to the responsibilities of trustees and the approval process.

The framework intends to promote –

– ease of entry,

– encourage new players,

– reduce compliance requirements,

– increase penetration,

– enhance market liquidity,

– facilitate investment diversification,

– foster innovation.

Existing asset management companies (AMCs) have a choice when it comes to their passive mutual funds:

• Separate Entity: They can create a new separate company specifically for their passive funds. This allows them to take advantage of the simplified regulations for MF Lite.
• Keep Together: They can continue managing their passive funds under their existing structure. Even in this case, they’ll still benefit from the relaxed rules for passive funds.

New entrants under MF Lite will not be allowed to launch exotic passive intelligent beta funds and thematic index funds, as these carry higher risks than plain vanilla broader index funds.

 How will MF lite be beneficial for investors?

Let us now look at different ways through which MF Lite will benefit the investors;

1. Lower Costs: MF Lite funds will likely have lower expense ratios than traditional mutual funds. It means investors pay less in fees, leading to higher returns over the long term.
2. Greater Accessibility:The relaxed entry requirements for MF Lite funds make it easier for smaller asset management companies to launch new products, increasing the variety of investment options available to investors.
3. Simplified Investment Process:MF Lite funds will require less documentation and paperwork, making it easier for investors to invest.
4. Potential for Higher Returns: Lower expense ratios can lead to higher returns for investors over the long term.

 Overall, MF Lite is a positive development for Indian investors seeking low-cost, diversified investment options. MF Lite can help investors achieve their financial goals by providing a more streamlined and efficient framework.

In addition, SEBI has released a set of new rules regarding the introduction of new investment products called ‘Investment Strategies’.

The objective of this separate investment category is to bridge the gap between mutual funds and portfolio management services in terms of portfolio construction flexibility. Currently, these strategies are unavailable through traditional mutual funds. In the future, they will be managed by professionals in accordance with the new regulations.

The Target Market for this product is high-net-worth individuals (HNIs) with high-risk appetites who want to capitalize on different strategies, such as long-short and inverse exchange-traded funds, which can significantly enhance their portfolios.

 Features of this new product are listed below :

1. The minimum investment limit for these schemes will be ₹10 lakh per investor across all strategies.
2. This asset class will fall somewhere between mutual funds and Portfolio Management Services (PMS).
3. These will have adequate safeguards such as no leverage, no investment in unlisted and unrated instruments beyond what is permissible for mutual funds.
4. Exposure to derivatives is limited to 25% of AUM for purposes other than hedging and rebalancing.

 Benefit for investors -This new asset class is expected to curb the proliferation of unregistered investment schemes, which assure unrealistic returns and exploit investors’ expectations, leading to increased financial risk. These offerings will be referred to as investment strategies to keep them separate from the traditional instruments of mutual funds.

Of course, the final verdict on how effective or impactful both these changes are will be known only once the Mutual Fund AMCs offer them. Until then, we can only wait and watch.