Are passive hybrid funds coming soon?

Securities and Exchange Board of India (SEBI), the markets regulator, intends to make it easier for new players to enter the mutual fund arena and launch passive funds. (Passive funds replicate an index such as the Sensex or the Nifty.)

SEBI issued a consultation paper to introduce Mutual Fund Lite Regulations on July 1, 2024.

While this is a consultation paper at the moment, where the public can submit their comments to the regulator by July 22, 2024, let's look at some of the proposals outlined by SEBI.

Introduction of Hybrid ETFs/index funds

Currently, passive funds can only mimic a debt or equity index. However, the current proposal calls for the launch of hybrid passive funds. These funds shall track a composite index comprising equity and debt.

To begin with, SEBI plans to allow only three categories of hybrid passive funds:

• Debt-oriented passive funds (25 per cent money in equity; 75 per cent in debt)
  
• Balanced passive funds (50-50 in equity and debt)
  
• Equity-oriented passive funds (75-25 in equity and debt)

Other notable mentions:

• A fund house can launch one fund per category.
  
• The debt indices for this purpose shall be constant duration indices. The indices will be specified by AMFI (Association of Mutual Funds in India), a licensing body for mutual fund distributors.
  
• The equity indices shall be broad-based indices. The index should comprise some equity shares of the 250 largest companies in terms of market capitalisation.

Relaxation for passive-only fund houses

The market regulator has also proposed lower net worth and profit requirements for sponsors and fund houses wishing to launch passive funds only.

If successful, these will be the rules for a sponsor to launch a fund house under the main eligibility route:

• The sponsor should have a positive net worth in the preceding five years.
  
• They should also have a net profit after tax (PAT) in three out of the last five years, including the fifth year.
  
• SEBI has proposed that the sponsor's average profit in the last five years should be at least Rs 5 crore. Currently, the requirement is Rs 10 crore.
  
• Meanwhile, the fund house needs to ensure that its net worth is at least Rs 35 crore. The net worth can be brought down to Rs 25 crore if it registers profits for five successive years.

The sponsor can also choose to launch a fund house through an alternate eligibility route.

In this case, they shall have to ensure the fund house has a net worth of at least Rs 75 crore. Currently, fund houses need to have a net worth of Rs 150 crore.

Simplified Scheme Information Document (SID)

The proposal also aims to streamline SID, a document that provides investors with all relevant information about a mutual fund.

Considering the limited risks associated with passively managed schemes, parameters such as investment strategy, instruments in which schemes shall invest and performance of the scheme benchmark shall be removed from the document.

That said, relevant parameters such as tracking error, tracking difference, name of the underlying benchmark, etc., shall be incorporated in the document.

Also read: The ESG smokescreen