Mutual fund lite: A new asset class on the horizon

Introduction The Securities and Exchange Board of India (SEBI) is preparing to introduce a new category of mutual funds known as Mutual Fund Lite, designed to bridge the gap between mutual funds (MFs) and portfolio management services (PMS). This initiative is expected to be discussed and potentially approved at SEBI’s upcoming board meeting on September 30, 2024.

What is Mutual Fund Lite? Mutual Fund Lite refers to a proposed framework where mutual funds that manage only passive schemes are subject to lighter regulations. This new asset class aims to simplify the entry process for new players, reduce compliance burdens, and foster a more competitive and cost-effective passive mutual fund industry.

Key Features and Benefits

Lower Minimum Net Worth: To encourage the establishment of new passive mutual funds, the framework proposes a reduced minimum net worth requirement. This lower threshold is expected to provide a significant boost to the cost-effective and competitive passive mutual fund sector.

Ease of Entry: The relaxed regulations are designed to facilitate easier market entry for new and existing players, allowing them to focus on passive investment strategies.

Encouragement for Innovation: By reducing the compliance requirements, SEBI aims to promote innovation within the industry, enabling mutual funds to develop new strategies and offerings.

Increased Market Penetration: The simplified regulatory framework is expected to increase market penetration and liquidity, making passive mutual fund schemes more accessible to a broader range of investors.

Industry Response Several existing mutual fund players have already started preparing for the launch of Mutual Fund Lite. Teams are being assembled, and strategies are being developed to capitalize on this new asset class.

Total Expense Ratio (TER) The total expense ratio for passive schemes is generally around 20 basis points. For example, a passive AUM of ₹10,000 crore would result in a TER of approximately ₹20 crore. Assuming half of this is the management fee, an asset management company (AMC) would earn a revenue of ₹10 crore from this AUM. To reach this revenue, an AMC needs to accumulate significant assets, emphasizing the importance of a lower minimum net worth for new entrants.

SEBI’s Consultation Paper In July, SEBI floated a consultation paper proposing these relaxed regulations, known as MF Lite Regulations. The paper highlighted measures to curb speculative activity in the futures and options (F&O) segment and suggested a minimum net worth of ₹35 crore for AMCs. This net worth must be maintained in liquid assets on a perpetual basis, ensuring financial stability and trust in the new mutual fund offerings.

Conclusion The introduction of Mutual Fund Lite is a strategic move by SEBI to enhance the passive mutual fund industry in India. By lowering the barriers to entry and reducing regulatory burdens, SEBI aims to create a more dynamic and innovative market environment. This new asset class is expected to attract both new players and seasoned industry veterans, fostering a competitive landscape that benefits investors through cost-effective and diverse investment options.