SEBI proposes new ‘high-risk’ category of mutual funds, seeks comments from AMFI

There has been a slew of portfolio management service (PMS) companies looking to enter the Rs 48 trillion Indian mutual fund industry.

The capital market regulator, Securities and Exchange Board of India (SEBI) has proposed to introduce a new mutual fund (MF) that comes with high-risk, and offers a chance to earn higher returns. SEBI has sent a letter to Association of Mutual Funds of India (AMFI; the MF industry's trade body).

Moneycontrol has reviewed this communication.

SEBI initially put forth this proposal at a meeting with AMFI. Following which, it wrote a letter to AMFI to internally consult about the possibility of such a category. A person with knowledge of the matter said that SEBI is concerned that many investors- in the race to earn higher returns (out of greed)- rush to high-risk Portfolio Management Services and sometimes to unregistered advisors.

Instead, he quoted SEBI's thinking- if mutual funds launch such a high risk product, then investors would more likely stay with mutual funds, which itself is tightly regulated by SEBI.

According to people familiar with the matter, SEBI hasn't specified the instruments that this fund can invest in. "Matters are still at consultation stage," said this official. But MF industry officials say that such a scheme might be allowed to invest in instruments like momentum stocks (small-cap, mid-cap, micro-cap and mini-cap stocks), use derivative and high-risk leverage strategies.

Although deliberations would now begin in the Rs 45-trillion Indian MF industry on how this new category might look like- or should look like- some officials that Moneycontrol spoke with expressed apprehension. They fear that if such schemes default or lose a lot of money due to their high-risk strategies, then not only would the brand of the fund house might get impacted, "but also that of the entire MF industry." This official pointed out to a recent case of credit risk debt funds going bad due to the Covid-19 induced illiquidity which hit unexpectedly and how the MF industry's reputation took a hit, as a result.

To ensure that small investors don't get pulled in by high-risk strategies, SEBI has proposed that this new category- if the proposal goes through- should have a higher minimal investment barrier.

This, too, might not guarantee that the lay investors wouldn't get lured by unregistered advisors or 'Finfluencers' who promise big gains through risk strategies to unsuspecting and gullible investors. PMS has a higher thresholds (minimum investment criteria) of Rs 50 lakh, but high networth individuals invest here; these are typically knowledgeable investors or at least those who have a better understanding of risk. Those who invest in mutual funds are smaller investors.

During a press conference held after a board meeting on November 25, SEBI Chairperson Madhabi Puri Buch said that there is informal PMS going on, which is below the Rs 50 lakh threshold. And that is in a sense, informal and camouflaged PMS.

According to the chairperson, there are three points in the scale of fund management in India. One is mutual funds, which is meant to be a retail product, second is PMS, where there is relatively more flexibility in terms of managing the portfolio compared to mutual funds. Third is AIFs, which have much more flexibility.

“We felt that possibly there is a need for a fourth point, somewhere between the mutual fund and the PMS. What form that takes, what will be its contours, we have not yet decided. The whole idea is at a very early conceptual stage. We need more points in this continuum, and we will deliberate a lot with the market participants. Maybe, it's a totally new asset class, we don't know, maybe we will define something completely new,” Buch said.