Big Changes Ahead for ETFs and Index Funds: SEBI’s New Rules Explained

Overview

The Securities and Exchange Board of India (SEBI) has announced new regulations that will affect how passively managed mutual fund schemes can invest in the securities of their sponsor’s group companies. These rules are designed to refine and improve the investment strategies of passive funds, such as Exchange Traded Funds (ETFs) and index funds.

Key Regulatory Changes

Under the new guidelines, mutual fund schemes are restricted from investing more than 25% of their net assets in the listed securities of the sponsor’s group companies. However, there is an exception for equity-oriented ETFs and index funds that track widely followed and non-customized indices. These funds can now invest up to 35% of their net asset value (NAV) in the sponsor’s group companies, as long as the investments reflect the weightage of the underlying index’s constituents.

Definition of Widely Tracked and Non-Bespoke Indices

Widely tracked and non-bespoke indices are those used by passive funds or serving as primary benchmarks for actively managed funds with collective assets under management (AUM) of ₹20,000 crore or more. SEBI has pinpointed 21 key indices based on Assets Under Management (AUM) data as of June 30, 2024. These indices include well-known benchmarks such as the Nifty 500, Nifty 50, Nifty Midcap 150, and BSE 500.

Implementation and Rebalancing

The list of qualifying indices will be updated every two years to guarantee relevancy. Subject to SEBI permission, the Association of Mutual Funds in India (AMFI) will release the updated list on its website by April 15 and October 15 of each year.

Rebalancing of portfolios is required for passive schemes that track indices not on the identified list within 30 business days of the circular’s release. The investment committee of the Asset Management Company (AMC) is required to provide an explanation within the following 30 business days if rebalancing is not finished within this time frame. The committee also has the power to, if needed, extend the rebalancing period by an additional 60 working days after the original deadline.

Implications for Investors

Investors have both opportunities and problems as a result of these regulatory changes:

Enhanced Replication: ETFs and index funds are able to more effectively replicate their benchmarks thanks to the greater investment cap, which might result in higher returns for investors.

Short-term Volatility: Rebalancing portfolios within a set period of time may cause short-term volatility, particularly for funds that must make major holding adjustments.

Investors should keep a careful eye on how these regulatory changes affect the funds they have selected and think about how it could affect their investing plans.