Whalesbook
What Happened
The Securities and Exchange Board of India (SEBI) is exploring an extension of the 50% portfolio overlap rule to cover passive mutual fund schemes. This includes index funds and exchange-traded funds (ETFs). Currently, this rule requires active mutual fund schemes to maintain a distinct portfolio to ensure they are not simply clones of one another. By proposing this change, the regulator intends to curb the excessive launch of passive products that offer very similar investment outcomes.
Why This Matters For Investors
The Indian mutual fund landscape has seen a major shift, with passive investing gaining significant popularity. In recent years, asset management companies have launched a high volume of new passive products, particularly in the sectoral and thematic categories. For an investor, the current market can feel crowded with multiple ETFs or index funds that track the same indices or sectors with very little difference in their holdings.
The proposed rule aims to address this product clutter. If enforced, it would require new passive fund launches to be genuinely different from existing offerings. This is designed to prevent scenarios where investors are offered a large variety of funds that are essentially identical, which can lead to confusion when selecting a scheme.
The Shift in Passive Investing
Data indicates a massive expansion in the passive segment over the last six years. Passive schemes have grown from representing just 8% of all mutual fund schemes in early 2020 to approximately 40% today. This growth has been accompanied by a sharp rise in investor money, with assets under management in passive products now totaling nearly ₹15 trillion.
This rapid growth has been driven by the ease of investing in low-cost index-tracking products. However, the regulator is concerned that the speed of new product launches—often referred to as New Fund Offers or NFOs—may outpace the need for such variety. There is a specific focus on restricting smart-beta funds, which use specific strategies to pick stocks, to ensure that the market does not become flooded with complex products that may not be suitable for all investors.
Regulatory Focus on Product Quality
This move is part of a broader regulatory effort to ensure that the mutual fund industry prioritizes investor protection over product volume. By capping the overlap, SEBI is pushing asset management companies to focus on unique value propositions rather than launching similar funds just to capture market share. The regulator has previously implemented similar guardrails for active sectoral funds, and this latest proposal signifies an extension of that philosophy into the passive space.
What Investors Should Track
Investors may want to watch for official circulars from SEBI regarding these proposed restrictions. The key monitorable will be how asset management companies adjust their future product roadmaps. If the rule is implemented, it will likely reduce the number of new passive fund launches in the market.
For those currently invested in or considering passive funds, it is helpful to verify the actual holdings of a fund against its peers. Even without this rule, understanding the portfolio overlap between different funds is a good practice to ensure true diversification in a portfolio. Future announcements from the regulator will clarify the exact criteria and timeline for these potential changes.