SEBI Proposes Major Reforms to Mutual Fund Schemes for Improved Clarity and Reduced Overlap

Markets regulator SEBI has proposed a significant review of mutual fund schemes to improve clarity and address the issue of portfolio overlap. The proposal comes after SEBI noticed a significant overlap in some schemes, leading to a necessity to introduce clear limits to the industry to avoid schemes with similar portfolios.

In its consultation paper, SEBI suggested that mutual funds should be permitted to offer both Value and Contra funds, with the condition that no more than 50% of the schemes’ portfolios 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 a higher-than-permitted overlap, the Asset Management Company (AMC) should 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, with the reasons for the extension properly recorded and maintained. If the deviation persists beyond this period, investors of both the schemes shall be given an exit option without any exit load.

SEBI also proposed that mutual funds should be permitted to invest the residual portions of their portfolios in equity, debt (including money market instruments), gold and silver, Real Estate Investment Trusts (REITs), and Infrastructure Investment Trusts (InvITs) under the equity category schemes.

Change in Terminology

SEBI recommended changes in the nomenclature of debt schemes to enhance investor understanding. The term ‘Duration’ should be replaced with ‘Term’ for better clarity. Additionally, the ‘Low Duration Fund’ should be renamed as ‘Ultra Short to Short Term Fund’ to better reflect the investment objective. The name of each debt scheme should indicate the fund’s duration, 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 funds, provided that no more than 60% of the portfolio in a sectoral debt scheme overlaps with any other sectoral debt or debt category scheme. This move should ensure sufficient availability of investment-grade papers within the chosen sectors. Mutual funds should also be permitted to invest the residual portion of their debt category schemes in REITs and InvITs, except for those with shorter durations, such as Overnight Fund, Liquid Fund, Ultra-Short Duration Fund, Low Duration Fund, and Money Market Fund, subject to regulatory limits applicable to this asset class.

Changes in Equity Saving Schemes

In terms of arbitrage funds, SEBI suggested that such schemes should be allowed to take exposure in debt instruments only through government securities with a maturity of less than one year and in repos backed by government bonds. For equity savings schemes, the regulator proposed that net equity exposure and arbitrage exposure should be mandated between 15% and 40%. With respect to hybrid category schemes, mutual funds should be allowed to invest the residual portion in REITs and InvITs, except in Dynamic Asset Allocation and Arbitrage Funds.

Furthermore, mutual funds should be permitted to offer different types of schemes within the solution-oriented category, offering varying mixes of equity and debt components. SEBI also recommended that mutual funds be allowed to offer solution-oriented life cycle fund of funds with a target date. These schemes could include lock-in features tailored for specific financial goals such as housing, marriage, and other objectives. Additionally, the schemes may offer varying lock-in periods, such as 3 years, 5 years, or 10 years, to suit different investor needs.

SEBI proposed a change in terminology, suggesting that the word ‘fund’ in scheme names be replaced with ‘scheme’. For example, instead of ‘Large Cap Fund’, it should be referred to as ‘Large Cap Scheme’. Overall, mutual fund offerings would continue to be grouped under five broad categories — Equity-oriented schemes, Debt-oriented schemes, Hybrid schemes, Solution-oriented schemes, and Others.

The Securities and Exchange Board of India (SEBI) has sought public comments till August 8 on the proposals.