The Securities and Exchange Board of India (Sebi) has overhauled norms on how much mutual fund portfolios can overlap, tightening rules for select schemes and pushing asset managers to meaningfully differentiate products that often looked strikingly similar.
In a circular issued on Thursday, the market regulator capped portfolio overlaps at 50% for sectoral and thematic equity schemes with other equity schemes within the same fund house, barring large-cap funds. The overlap must be calculated quarterly using the average of daily portfolio overlap values over the quarter. Existing schemes have three years to comply, failing which they will have to be mandatorily merged.
The move follows a consultation process that started in 2024 to curb overlap in thematic (with focus on a specific macro theme such as infrastructure) and sectoral schemes (with focus on a specific sector or industry) as well as value and contra funds to ensure that mutual funds do not package the same scrips into different schemes, effectively reducing the value offered to investors.
“The move ensures that schemes are true to label, brings transparency, and is good for investors. By introducing overlapping clause, an attempt is being made to have funds not have too common a portfolio, and the investor can invest in funds having diversified portfolios, thus avoiding the risk of portfolio concentration,” said Jimmy Patel, managing director at Quantum Mutual Fund.
mint reported in January that Sebi had begun scrutinizing new fund offers (NFOs) for portfolio overlap even before formally notifying the rules.
Under current regulations, fund houses can launch only one scheme per equity category, but there is no cap on sectoral and thematic funds. In the past year, there were 37 sectoral and thematic NFOs compared with 19 across the entire equity category, according to the Association of Mutual Funds in India (Amfi).
The regulator has also permitted asset management companies (AMCs) to offer both value and contra funds, two strategies that were previously restricted to one per fund house, subject to the same 50% overlap cap between the two.
A value fund follows a strategy of investing in stocks perceived to be undervalued, while a contra fund takes positions against prevailing market trends. While the strategies can appear similar in practice, the overlap ceiling aims to ensure they are not run as near-identical portfolios under different labels.
Compliance timeline
To ease the transition, Sebi has laid down a path for compliance. In the first year, asset management companies must reduce 35% of the excess overlap. In the second year, they must cut an additional 35%, and the remaining 30% in the third year. If a scheme still fails to meet the threshold after three years, it must be merged in line with regulatory provisions.
Sebi has also discontinued solution-oriented schemes with immediate effect. Such schemes, which are typically positioned around long-term goals such as retirement or children’s education, will stop accepting fresh inflows and must be merged with other schemes that have a similar asset allocation and risk profile, with prior approval from the regulator.
Quantum’s Patel said that although the current schemes available under the solution-oriented funds can be made into a lifecycle fund, it may not fit right for children’s fund.
“Children-related products will need a tweak for getting fit under the new categorization norms,” he added.
The circular also introduces a new category of funds called the lifecycle funds. These funds can invest across equity, debt, infrastructure investment trusts (InvITs), exchange-traded commodity derivatives, and gold and silver ETFs. Mutual funds may launch such schemes with a minimum tenure of five years and a maximum of 30 years, in multiples of five.
At any given time, only six lifecycle funds can be open for subscription. If a fund has less than one year to maturity, it may be merged with the nearest maturity lifecycle fund, subject to positive consent from unit holders. The structure seeks to offer long-term, goal-linked investing options while limiting product clutter.
The circular also clarifies how the “residual portion” of portfolios may be allocated across categories. Residual portions are the part of a scheme’s corpus that are not invested in its core asset classes as provided in the scheme characteristics.
In hybrid schemes, the residual portion may now be invested in InvITs, exchange-traded commodity derivatives, gold ETFs and silver ETFs, within regulatory ceilings. Debt schemes will invest their residual portion in InvITs, except in overnight, liquid, ultra-short duration, low duration and money market funds. Equity schemes will invest residual portions in equity, money market instruments, other liquid instruments, gold and silver instruments, and InvITs, according to prescribed limits. The clarifications expand flexibility but within clearly-defined boundaries.
“Previously restricted mainly to cash, debt, or money market instruments just to manage liquidity, equity fund managers can now actively diversify excess capital into InvITs, REITs, gold, and silver to hedge against market volatility,” said Archit Doshi, senior vice-president at Prabhudas Lilladher Capital Group.
Sebi has also introduced guardrails for medium-term and medium-to-long-term debt funds. These schemes typically maintain durations of three to four years and four to seven years, respectively. Under the new framework, fund managers may temporarily reduce portfolio duration to as low as one year if they anticipate adverse interest rate conditions.
The market watchdog has also allowed for a new category called sectoral debt schemes to be launched only if there is sufficient availability of investment-grade paper in the targeted sector.
“Fixed-income funds were traditionally categorized merely by their duration and yield profiles. Now, with sectoral debt funds, investors can target specific, capital-intensive engines of the nation’s economy while still securing the relative safety of highly-rated corporate bonds,” said Doshi.
