Sebi moots allowing Indian mutual funds to invest in overseas funds

The investment framework for mutual funds do not explicitly forbid them from investing in such funds, Indian mutual funds usually avoid doing so.

The market regulator proposes allowing Indian mutual funds to invest in overseas mutual funds or unit trusts that in turn invest a portion of their funds in Indian securities.

It has proposed that these mutual funds be allowed to invest in such overseas funds with conditions including a 20 percent upper limit on overseas funds's total exposure to Indian securities.

In a consultation paper floated on May 17, the Securities and Exchange Board of India (Sebi) said that, though the investment framework for mutual funds do not explicitly forbid them from investing in such funds, Indian mutual funds usually avoid doing so.

This affects Indian mutual funds' ability to diversify their portfolio. They are unable to invest in foreign funds that may allocate a portion of their funds to Indian securities considering the country's strong economic growth, according to Sebi's paper.

It cited examples to illustrate this: as of April 30, 2024, the MSCI Emerging Markets Index has 18.08 percent weightage to Indian securities. Similarly, JP Morgan's 'Emerging Markets Opportunities Fund' holds approximately 15 percent in Indian investments, according to its latest factsheet as on March 31, 2024

The paper said, "In order to diversify the portfolio, and as part of overseas fund of funds (‘FoFs’) schemes, the Indian Mutual Funds often invest in overseas securities including units of overseas MF/UTs, ETFs and index funds. However, ambiguity regarding investments in such overseas funds that may invest certain portion of their funds in Indian securities deters Mutual Funds from investing in those overseas MF/UTs, ETFs and index funds that invest in a basket of countries, which may include India."

The regulator has also suggested conditions to ensure that these structures are not misused and to ensure that investors get efficient cost structures.

The paper elaborated on the need for fund to align with its labels: " If an overseas Fund of Funds (FoFs) offered by Indian Mutual Fund invests in overseas MF/UTs with a significant allocation to Indian securities, it may not be true to the fund’s label, and may not reflect the overall purpose of investing in such FoFs."

It added that by investing in Indian securities directly would also be more cost-effective for Indian clients than investing through such overseas fund of funds.

Therefore, the regulator suggested Indian mutual funds invest only in overseas funds that have a limited exposure--an upper limit of 20 percent--to Indian securities.

Other than this, the regulator has also proposed how the Indian mutual funds should act when this limit is breached and when the overseas fund is rebalancing their portfolio.