Mutual Funds Lite

Introduction

The SEBI (Mutual Funds) Regulations, 1996 (“MF Regulations”) and the current regulatory framework inter alia provide for regulation of Mutual Funds and the schemes managed thereunder. Mutual Fund Lite is a simplified version of traditional mutual funds, aimed specifically at making it easier to invest in passive investment products like index funds and exchange-traded funds (ETFs). Currently, both active and passive mutual funds are regulated under the same framework, which does not differentiate based on factors like the net worth, past track record, or profitability of the fund managers.

This means that even for passive fund providers, the entry requirements and ongoing compliance obligations are just as demanding as those for active fund managers.

The Mutual Fund Lite approach aims to ease this by recognizing low-cost passive schemes, particularly those that invest in Government Securities (G-Secs), Treasury Bills (T-Bills), and State Development Loans (SDLs) with fixed durations. If the combined Assets Under Management (AUM) of such passive debt funds exceeds Rs 5,000 crore by December 31 of any financial year, they will be included under this simplified framework.

Purpose of Regulations for Mutual Fund Lite

Mutual funds are generally divided into two categories: actively managed and passively managed schemes. Actively managed funds rely on the skill of fund managers or Asset Management Companies (AMCs), who decide the investment strategy and select individual securities. In contrast, passive funds—such as index funds, ETFs, and funds of funds (FoFs) that invest in ETFs—aim to mirror the performance of specific market indices like NIFTY50 or SENSEX, requiring minimal human involvement.

Because passive funds are simpler to manage, more transparent, and cost-effective, they have grown significantly in popularity. As of June 2024, the assets under management (AUM) of passive funds have exceeded INR 10 lakh crore, accounting for 17% of the total mutual fund market—a figure expected to rise further.

Currently, all mutual funds in India are regulated under the SEBI (Mutual Funds) Regulations, 1996, which were designed primarily with active funds in mind. These rules are often complex and stringent to address the risks involved in active management. However, passive funds operate with lower risk and complexity, suggesting a need for a more flexible, targeted regulatory framework.

Recognizing this, SEBI has proposed the Mutual Fund Lite Framework—a separate set of regulations tailored to passive investment products.

This Framework Aims To:

1. Lower Entry Barriers for Fund Providers
2. Simplify Compliance
3. Encourage Broader Participation from New and Smaller Players
4. Boost Financial Inclusion
5. Promote Innovation and Competition in the Market

By doing so, it can help diversify investment options for retail investors, improve market liquidity, and expand the overall mutual fund ecosystem in India.

Key Features of the Mutual Fund Lite Framework

1. The Mutual Fund Lite Framework is designed to ease regulatory requirements for both mutual fund entities and investment products in the passive fund space. It targets two main areas:
   • MF Operators – This includes entities such as Sponsors, Trustees, and Asset Management Companies (AMCs) that wish to register and operate within the MF Lite segment.
   • MF Products – This covers both existing passive mutual fund schemes and any new ones that may be introduced in the future.
2. To implement this framework, a new Chapter XI has been added to the SEBI (Mutual Funds) Regulations, 1996, through an amendment. This new chapter formally incorporates the regulatory provisions specific to MF Lite. The main features in it include:
   • Eased Eligibility for Sponsors
     • Sponsors can enter the MF Lite segment with reduced requirements for net worth and financial track record.
     • AMCs managing passive funds may voluntarily designate the Chief Compliance Officer (CCO) as the Chief Risk Officer (CRO), providing operational flexibility.
   • Simplified Role of Trustees
     • Trustees have narrowed responsibilities, focusing mainly on compliance, conflict resolution, and investor protection.
   • Streamlined Compliance and Reporting
     • Introduction of a simplified Scheme Information Document (SID), with emphasis on tracking error and tracking difference.
     • Reduced reporting frequency:
       • Monthly for debt-oriented schemes
       • Quarterly for equity-oriented schemes
     • Annual reports by AMCs will now replace the traditional trustee reporting to SEBI.
   • Enhanced Investor Education
     • AMCs must allocate a portion of their Total Expense Ratio (TER) to investor awareness initiatives.
     • At least 5% of this allocation must be used specifically to promote passive investment schemes.
   • Promotion of Hybrid Passive Funds
     • The framework encourages the creation of hybrid ETFs that track composite indices of both equity and debt, expanding options for conservative investors seeking diversified exposure.

Advancing Inclusive and Accessible Investing

Mutual Fund Lite Framework represents a progressive step toward making India’s mutual fund landscape more inclusive, efficient, innovation-driven and ‘lite’. By streamlining regulations for passive investment schemes, SEBI is enabling broader market participation, encouraging new entrants, and promoting a more diversified investment ecosystem.

Whether you’re an investor, fund manager, or an Asset Management Company, Mutual Fund Lite opens up new opportunities for simplified, cost-effective investing.

Disclaimer

The information provided in this article is intended for general informational purposes only and should not be construed as legal advice. The content of this article is not intended to create and receipt of it does not constitute any relationship. Readers should not act upon this information without seeking professional legal counsel.