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SEBI has issued a circular on development of passive funds on Monday evening.
Quite a few steps like putting a cap of Rs.25 crore on unit creation through AMCs, giving recognition to market makers and asking AMCs and AMFI to launch a passive focussed IAPs can give a much-needed boost to the passives in India.
Let us look at these key changes that matter to you:
Debt ETFs/index funds
SEBI has allowed fund houses to launch three new categories of debt funds apart from target maturity ETFs/index funds and gilt ETFs/index funds. These three categories are ETFs/index funds focussing on corporate bond markets, government securities markets and a combination of both – corporate bond and g-sec.
Since the secondary market of fixed income funds does not have trading volumes and adequate liquidity like equity markets, SEBI has given an option to ETFs/index funds to replicate the underlying index rather than hugging it.
Also, debt ETFs/index funds can deploy up to 20% of the total corpus outside the index. However, such securities should have similar maturity and credit rating. For instance, if the overall credit rating of index is AAA then the fund house will have to invest the 20% corpus in AAA rated bonds of similar maturity.
But fund houses may hardly use this 20% window. They may stick to the index as they can complete their 100% portfolio with at least 60% weightage of index. Simply put, if an underlying index has 10 securities and each security has 10% weightage, an ETF/index fund can be created with just 7 securities –15% allocation each to 6 securities and the remaining 10% in the seventh security.
In g-sec focussed passive funds, fund managers will have to maintain duration similar to the underlying index with a permissible deviation of +-10%.
Another important factor that needs to be highlighted is tracking difference. There is a big difference between tracking error and tracking difference. While tracking error is difference between standard deviation of the fund and its underlying index, tracking difference is simply the difference between returns generated by the fund and the benchmark.
Debt ETFs/index funds can have tracking difference of up to 1.25%. Lower the difference, better the fund.
Market makers
With the new circular, SEBI has given recognition to market makers (MMs). While they have been around for long in the industry, there was no official recognition given to them.
Market makers are broking firms who create ETF units regularly at the prevailing market prices and facilitate trading in these units to investors. Their major income is spread i.e. difference between bid and ask price.
However, with the market regulator asking fund houses to incentivize MMs on the basis of liquidity generation, many large brokers will be interested in this business. Currently, there are only a handful of MMs in the passive industry.
Creating units with AMCs gets difficult but liquidity will improve
SEBI has put a cap of on minimum investment amount with AMCs to create units. Now, investor investing at least Rs.25 crore can directly deal with AMCs for unit creation of ETFs. This would pave the way to create liquidity in the secondary markets as majority of transaction will happen through MMs.
Passive ELSS
Fund houses have an option to either offer actively managed ELSS or launch a new passive ELSS.
Currently, 36 out of 41 fund houses offer an active plan in the ELSS category leaving no room practicality for passive ELSS. The industry may give this offering a miss.
Focussed campaign on passives
SEBI has allowed fund houses to spend 1bps of their passive fund AUM to spread awareness on passives through a focussed campaign.
Just like ‘Mutual Fund Sahi Hai’ campaign, which has become quite popular among masses, AMFI along with AMCs will work on new campaign to make passive funds popular.
