SEBI Proposes Key Mutual Fund Reforms Amid Soaring AUMs

In response to the dynamic growth and increasing complexity of India’s mutual fund ecosystem, the Securities and Exchange Board of India (SEBI) has released a comprehensive consultation paper proposing a series of regulatory changes. The paper, aimed at improving scheme flexibility and maintaining strategy consistency, also seeks industry and public feedback by August 8. These proposals come at a time when the mutual fund industry has reached an all-time high with assets under management (AUM) nearing ₹75 trillion (~$870 billion), prompting the need for regulatory refinements. SEBI's proposals include significant reforms in fund categorization, portfolio construction, and conditions for launching new schemes — with ripple effects for investors, fund managers, and asset management companies (AMCs).

SEBI’s Consultation Paper: A Push for Flexibility and Efficiency

SEBI’s latest consultation paper outlines critical changes to existing mutual fund rules. A key proposal is to allow AMCs to launch both value and contra funds, provided their portfolio overlap does not exceed 50%. Currently, asset managers can only operate one of the two. Value funds invest in undervalued stocks, while contra funds go against market sentiment — and while both employ fundamentally distinct approaches, there’s often some overlap in execution. SEBI aims to maintain these distinctions without limiting choice.

Value vs Contra Funds: A New Co-Existence Model

The proposal to allow both value and contra funds from the same AMC is aimed at broadening product offerings and providing greater choice to investors. However, to avoid redundancy, the 50% overlap cap has been introduced. This move could boost innovation in fund strategy design, allowing AMCs to fine-tune offerings for different investor risk appetites. It also helps SEBI balance regulatory discipline with market freedom.

Diversifying Residual Investments in Equity and Debt Schemes

Currently, equity mutual fund schemes are required to invest at least 65% in equity-related instruments. SEBI is now seeking views on whether the remaining 35% can be more diversified, including into debt, gold, silver, and real estate investment trusts (REITs). Similarly, debt funds (except short-duration schemes) may soon be allowed to park their non-core assets in REITs or infrastructure investment trusts (InvITs), offering greater yield potential and risk diversification.

When and How AMCs Can Launch Additional Funds

SEBI’s paper introduces detailed guidelines for when an AMC can launch a second scheme within the same category. A new fund can be introduced only if the existing fund is over five years old and has crossed ₹50,000 crore in AUM. The new scheme must share similar objectives, strategies, and features, but will have a separate Scheme Information Document (SID).

To reduce confusion:

·       The older fund must stop accepting fresh investments (except for existing SIPs).

·       Naming conventions must be transparent, such as “Large Cap Fund – Series 1” and “Large Cap Fund – Series 2.”

·       Total Expense Ratio (TER) of the new fund must not exceed that of the original.

Why the Move is Being Considered

As the mutual fund industry matures, some schemes have grown unwieldy in size. For instance, Parag Parikh Flexi Cap Fund now manages over ₹1 lakh crore. Large AUMs in actively managed equity schemes may dilute strategy purity, as fund managers are compelled to prioritize liquidity over stock selection — especially in small-cap or mid-cap segments. SEBI’s proposal is a direct response to these limitations, aiming to preserve nimbleness and adherence to category mandates.

The Double-Edged Sword: Implications for Investors and AMCs

While the intent is to improve scheme efficiency and investor choice, critics have flagged potential pitfalls. Kirtan A Shah, founder of Credence Wealth, raised concerns on social media, noting that launching a new fund would halt fresh inflows into the older one, potentially destabilizing it. “If I was an investor in the first fund, I will pull off my investments,” he warned, as redemptions without new inflows could impact fund performance.

Additionally, the industry already hosts over 1,790 mutual fund schemes. More scheme variants could further confuse retail investors, diluting the benefits of product diversification.

Balancing Innovation with Investor Clarity

SEBI’s proposals mark a thoughtful effort to address the challenges of scale and strategy drift in India’s booming mutual fund sector. By enabling more nuanced fund launches and diversified portfolios, the regulator is embracing innovation. However, it must tread carefully to avoid overwhelming investors and compromising the performance of legacy funds. The industry’s feedback, due by August 8, will be crucial in refining these proposals into a regulatory framework that enhances both market efficiency and investor confidence.