Mutual funds get a structural reset as Sebi introduces new norms

Sebi has issued a sweeping recategorisation of mutual fund schemes, reshaping how equity, debt, and hybrid funds are structured and managed. The overhaul, which replaces the framework in place since 2017, introduces new categories, retires some existing ones, and changes investment rules across schemes. Here's a look at the implications for fund houses and investors.

What are the key changes made in the recategorisation?
The recategorisation introduces several structural changes across equity, debt, and hybrid schemes. Sebi has created a new category of lifecycle funds and discontinued solution-oriented schemes such as retirement and children's funds. Fund houses are now allowed to offer both value, and contra funds, subject to a 50% portfolio overlap cap, with similar limits also applied to sectoral and thematic funds.


The rules also expand the scope of residual allocations in equity and hybrid schemes to include assets such as gold and silver instruments and InvITs. In addition, arbitrage fund debt exposure is now restricted to short-term government securities and repo in government bonds.

How will this benefit investors?
The changes aim to make mutual funds simpler to understand and compare. Standardised categories and naming clarify what each scheme does, lifecycle funds introduce a goal-based option, and tighter overlap rules with new disclosures improve transparency, while phasing out older schemes reduces clutter.

What is this new category-Life Cycle funds?
Life Cycle Funds are open-ended, target-date funds that follow a glide-path strategy, investing across equity, debt, commodity derivatives, InvITs, and precious metals ETFs.

These funds can be launched with a tenure ranging from 5 to 30 years, in multiples of five years. They follow prescribed asset-allocation bands based on years to maturity and carry graded exit loads--3% if redeemed within one year of investment, 2% within two years, and 1% within three years. The structure gradually reduces equity exposure as the maturity date approaches, helping align the portfolio with the investor's goal timeline.

What happens to existing solution-oriented schemes like children's gift fund and retirement funds?
The solution-oriented schemes category stands discontinued with immediate effect. Existing schemes under this category are required to stop accepting subscriptions with immediate effect and shall be merged with another scheme having a similar asset allocation and risk profile.

Can mutual funds now offer both value and contra funds? What has changed for sectoral and thematic funds?
Earlier, mutual funds could offer either a value fund or a contra fund. Under the new regulations, they can offer both, provided the portfolio overlap between the two does not exceed 50%.

Similarly, for sectoral and thematic equity schemes, mutual funds must ensure that portfolio overlap with other equity schemes in the same category-or across other equity categories (except large-cap schemes)-does not exceed 50%.

CAN EQUITY MUTUAL FUND SCHEMES ALSO INVEST IN GOLD AND SILVER NOW?
Yes. Under the new rules, equity schemes can deploy their residual allocation in commodity derivatives, money market and other liquid instruments, gold and silver instruments, and InvITs, within regulatory limits. For example, a largecap fund must invest at least 80% in large-cap stocks, while the remaining 20% can now also include gold and silver ETFs.

WHAT ARE THE LIKELY IMPLICATIONS FOR ARBITRAGE FUNDS?
Arbitrage funds must now restrict their debt exposure to government securities with a maturity of less than one year and repo in government bonds. Arbitrage funds typically hold around 30% in fixed-income securities. This, along with the increase in securities transaction tax (STT) from April 1, is likely to lower arbitrage fund returns by about 50 basis points.