SEBI issues directives for passive funds

Passive funds have been quite the rage in recent times, both on the equity and the debt side. The capital market regulator, SEBI has come out with a series of guidelines focused on passive funds. Broadly, there are important announcements around two segments of products.

One is that they have paved the way for passively-managed funds in the tax-saving category. These funds will be based on any index tracking the top 250 stocks by market capitalisation. But there is a catch here - an AMC can only have either an active or a passive ELSS fund. Thus, we will have to wait and see whether there are any takers in the near future since almost all the existing set of fund companies already have an ELSS fund running in the active domain.

In another big announcement, SEBI has put out nuanced rules for debt ETFs and index funds. The regulator has specified that debt passive funds can be mounted on indices comprising corporate bond securities or government securities (including t-bills and/or state development loans (SDLs)) or a combination of both corporate bonds and G-secs/T-bills/SDLs.

Without getting too much into the specifics, broadly the rules are governing the constitution and replication of the underlying index. Given that replication can be more challenging in debt passive funds, SEBI has provided limits to how much a fund can deviate from the underlying index in terms of issuer-level, credit-rating and duration-level exposures.

The other regulations relate to the entire passive-fund domain. The regulator has set the maximum permissible limit on tracking error for equity passives and tracking difference for debt passives. Broadly, these metrics tell you how closer the fund returns are to the returns of the underlying index. Further, SEBI has prescribed a few regulations to enhance liquidity in passive funds, for instance, any direct transaction with the fund house will be for an amount greater than Rs 25 crore. This will help improve the demand-supply dynamics on exchanges. SEBI has also specified certain disclosure practices that will be required to be followed by AMCs with respect to their passive offerings.

These rules kick in from July 1, 2022. While these regulations have been announced, if you want to go through them in great detail, you can read the SEBI circular.

Conclusion
Although the passively-managed funds on the debt side are a relatively new phenomenon, it's not that these funds have not existed. But the new norms lay the mechanics of running these funds in much greater detail.

Among such funds that are available to Indian investors, it is Edelweiss's Bharat Bond ETFs which have been able to generate notable traction, while many other AMCs have launched quite a few passive debt funds in target-maturity structures and many are also in the process of seeking approval from SEBI, but they are yet to catch investors' eye in a significant way.