SEBI's new rules for passive mutual funds: What it means for investors

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The Securities and Exchange Board of India (SEBI) has introduced new regulations impacting investments by passively managed mutual fund schemes in the group companies of their sponsors.

These changes aim to streamline and enhance the investment strategies of passive funds such as Exchange Traded Funds (ETFs) and index funds.

Key changes in the regulation

Under the new rules, no mutual fund scheme is allowed to invest more than 25% of its net assets in the listed securities of group companies of the sponsor.

However, equity-oriented ETFs and index funds that follow widely tracked and non-bespoke indices are granted some leeway.

They can now invest up to 35% of their net asset value (NAV) in the sponsor’s group companies, provided the investments align with the weightage of the constituents of the underlying index.

Definition of widely tracked and non-bespoke indices

Widely tracked and non-bespoke indices are defined as those tracked by passive funds or serving as primary benchmarks for actively managed funds with collective assets under management (AUM) of ₹20,000 crore and above.

SEBI has identified 21 such indices based on AUM as of June 30, 2024, including popular benchmarks like the Nifty 500, Nifty 50, Nifty Midcap 150, and BSE 500.

Implementation and rebalancing

The list of qualifying indices will be updated biannually, with AMFI (Association of Mutual Funds in India) publishing the revised list on its website by April 15 and October 15 each year, following SEBI’s approval.

Passive schemes based on indices not included in the identified list must rebalance their portfolios within 30 business days from the issuance of the circular.

If rebalancing is not completed within this period, the investment committee of the Asset Management Company (AMC) must provide an explanation within 30 business days.

The committee may extend the rebalancing timeline up to 60 business days from the end of the mandated rebalancing period if necessary.

Implications for investors

For investors, these changes bring a mixed bag of opportunities and challenges.

On one hand, the increased investment cap allows ETFs and index funds to better replicate their benchmarks without the constraints of the previous 25% limit.

This can lead to more accurate tracking and potentially better returns for investors.

On the other hand, the requirement to rebalance portfolios within a specified timeframe could introduce short-term volatility, especially for funds that need to adjust significant portions of their holdings, experts say.

Investors should monitor how their chosen funds respond to these changes and consider the impact on their investment strategy.

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