Sebi proposes new type of high-risk mutual fund to compete with PMS
Oct 26, 2023
Summary
Currently, high-risk strategies are housed in portfolio management services, which have a minimum ticket size of ₹50 lakh
Markets regulator Sebi has written to the Association of Mutual Funds in India (AMFI), seeking the views of individual asset management companies (AMCs) on a new mutual fund category. The proposed category will cater to investors with a high risk appetite and will have a higher minimum investment. It will also have relaxed norms to generate high returns.
“Such funds may include junk bonds or long-short strategies," said a person with knowledge of the matter who did not wish to be named. Another person associated with the mutual fund industry confirmed the news.
Currently, high-risk strategies are housed in portfolio management services but they have a minimum ticket size of ₹50 lakh. Instead, they could be housed in mutual funds at a lower ticket size but higher than ordinary mutual funds, a letter from AMFI to fund houses read. Sebi asked AMFI to send the industry’s responses by 25 October, according to a letter from AMFI to fund houses, a copy of which Mint has seen. The responses should suggest relaxations for the new category and the minimum ticket size.
Portfolio management services (PMS) are not subject to the same risk controls as mutual funds, such as the 10% cap on exposure to individual stocks. This allows them to take concentrated bets on a few companies. Alternative investment funds (AIFs) can use leverage to invest and can also run long-short strategies (to benefit from both bull and bear markets). A large number of such freedoms are not available in the tightly controlled MF industry. Mutual funds are not allowed to take ‘naked short’ positions but are allowed to use derivatives as a hedge.
A mutual fund is also a more tax-efficient vehicle to house high risk strategies than a PMS. This is because investors pay tax whenever the PMS books profits while MF investors do not pay tax until the fund is redeemed. Hence high returns in a mutual fund can lead to more tax-efficient outcomes for investors than in alternatives like PMS or AIF.
On the debt side, mutual funds have become highly risk averse after 2020. The shocking closure of six Franklin Templeton debt schemes in 2020 resulted in a slew of fresh regulations for debt mutual funds. There was also a wave of fear among fund managers and AMCs. Funds in categories such as credit risk also avoided high-yield debt. Instead, such high-yield and high-risk debt was increasingly bought by alternative investment funds or AIFs. This has deprived mutual fund investors of products that can potentially produce high returns through strategies such as credit risk.
Experts are cautious on the development. “I’m not sure if retail investors will understand the risk inherent in such a category. Even today, small cap funds are seeing huge flows on the back of returns," said Suresh Sadagopan, founder, Ladder 7 Financial Advisories.
[Mint]
