MC Explainer | All you need to know about the new asset class proposed by Sebi

Mutual funds with average assets under management (AUM) exceeding Rs 10,000 crore over three years or those managed by experienced Chief Investment Officers (CIOs) and fund managers will be eligible to launch this new asset class.

Investor interest is high in the new asset class - proposed by capital markets regulator Securities and Exchange Board of India (Sebi) - aimed at those with higher risk-taking capacity than a mutual fund but do not have the corpus to qualify for investment in a PMS fund.

This is significant as there is a large gap between the two buckets, with mutual funds SIPs starting as low as Rs 100 while PMS mandates a minimum investment size of Rs 50 lakh.

Also read: Sebi proposes new asset class placed between MFs and PMS for higher risk takers

Here is all that one needs to know about the Sebi proposal:

What new asset class is Sebi proposing?

Sebi is proposing to introduce a new asset class that falls between mutual funds and PMS, aimed to cater investors with a higher risk appetite, offering them opportunities with potentially higher returns.

Why does Sebi see the need for this new asset class?

Sebi, in the report, notes that it recognised a gap in the current investment spectrum, where mutual funds cater to retail investors with varying risk appetites, while PMS and alternative investment funds (AIFs) aim at more sophisticated, high-networth investors. This proposed asset class, according to Sebi, is intended to bridge the gap, and provide an intermediate investment option with potentially higher returns and higher risk.

What kind of investment strategies will this new asset class include?

Redemption frequencies can vary (daily, weekly, fortnightly, monthly, quarterly, annually, or fixed maturity) to manage liquidity effectively while accommodating investor needs. Only Sebi-approved strategies can be launched under the new asset class, such as Long-Short Equity Funds and Inverse ETFs/Funds for inverse index returns.

What exactly are these strategies?

Long-Short Equity Funds involve taking long and short positions in equity and equity-related instruments. Inverse ETFs/Funds aim to generate returns negatively correlated with the underlying index.

Are such products or strategies available globally?

Yes. These products are currently not allowed in India, but they do exist in other jurisdictions. For instance, there are various long-short equity funds in the US, regulated by the Securities Exchange Commission (SEC), offering hedge fund like strategies with the liquidity of mutual funds.

Similarly, Australia offers many inverse ETF products that use derivative products to let investors hedge against market downturns or to speculate on market declines.

What is the minimal investment threshold?

The minimum investment requirement for the New Asset Class is Rs 10 lakh per investor. This threshold aims to discourage retail investors from participating in this product while attracting those with investible surplus ranging from Rs 10-50 lakh. Investors will have the option to choose options such as Systematic Investment Plan (SIP), Systematic Withdrawal Plan (SWP), and Systematic Transfer Plan (STP) for investing in strategies under the new asset class. To maintain investment continuity, an investor's total invested amount should not drop below Rs 10 lakh due to actions like withdrawals or systematic transactions.

Who can launch these products?

Mutual funds with average assets under management (AUM) exceeding Rs 10,000 crore over three years or those managed by experienced Chief Investment Officers (CIOs) and fund managers will be eligible to launch this new asset class.

What other relaxations are being proposed for this new asset class?

Debt securities are restricted to 10 percent of NAV, extendable to 12 percent with approval, and up to 20 percent with further approval. Credit risk-based limits for securities range from 10 percent for AAA-rated to 6 percent for A and below, each extendable by 2 percent to 5 percent with approval. Ownership of voting rights-carrying paid-up capital is capped at 10 percent to 15 percent. Mutual Funds can also allocate up to 10 percent of their total assets to REITs.

What does the consultation paper say about investing in derivatives?

It suggests that the total gross exposure, including derivatives, should not surpass 100 percent of net assets, and exposure via exchange-traded derivatives must not exceed 50 percent. Index funds or ETFs under new asset classes on specified indices are exempt from this rule, and exposure to derivatives of a single stock should not exceed 10 percent of net assets.

What happens next?

Sebi has sought feedback from the Association of Mutual Funds in India (AMFI) and individual asset management companies regarding the structure and asset allocation of this new category. Suggestions and feedback can be submitted till August 6.

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