MFs to launch passively managed hybrid index funds/ETFs: SEBI

SEBI has allowed fund houses to launch passively managed hybrid index funds or ETFs under the new MF Lite Regulations.

To start with, MF Lite fund houses can launch three categories of hybrid passive funds:

• Balanced (Equity 40%-60% and Debt 40%-60%)
• Equity Oriented (Equity 65%-80% and Debt 20%-35%)  
• Debt oriented (Debt 65%-80% and Equity 20%-35%)

Note: Only constant-duration indices are permitted for the debt component

Such fund houses can launch one index fund and one ETF under each category. The fund houses will have to raise at least Rs.10 crore to start the fund, said SEBI.

Further, the market regulator has also allowed fund houses to launch closed ended debt passive funds under the MF Lite Regulations.

In this structure, fund houses can launch target maturity closed ended index funds and ETFs.

Overall, SEBI has finalized the MF lite framework. MF Lite was introduced to simplify regulations for fund houses managing only passive schemes like index funds, ETFs and Fund of Funds (FoFs).

Let us look at some key highlights of the MF Lite Regulations, which will come into effect from March 16, 2025:

• In the first phase, fund houses operating under MF Lite regulations can launch schemes tracking performance of indices having AUM of at least Rs.5000 crore. This indicates that the MF Lite fund houses cannot launch schemes based on new and innovative benchmarks
• However, MF lite fund houses can launch commodity index funds or ETFs without complying with any AUM regulations
• Further, overseas ETFs/FoFs with a single underlying fund should have AUM of over USD 20 billion
• FoFs investing in multiple indices are excluded in the first phase

Further, the regulations offer two routes for entry of MF Lite sponsors - experienced financial institutions and newer entrants. For companies with established track records, the main route requires:

• Positive networth in all preceding five years
• The sponsor’s liquid net worth should be higher than their capital contribution to the MF Lite AMC
• Net profits in three out of the previous five years for the sponsor or average net annual profit of at least Rs. 5 crore (after depreciation, interest and tax) over five years
• Minimum networth requirement of Rs. 35 crore for the Mutual Fund Lite AMC
• Option to reduce networth to Rs. 25 crore after five consecutive profitable years for the mutual fund lite AMC

For companies that don't meet the standard track record requirements, SEBI has provided an alternate route with additional safeguards:

• Sponsor has to provide Rs.75 crore, which will be held in a three-year lock-in period
• Minimum networth requirement of Rs.50 crore for the asset management company
• Combined experience of at least 20 years of key personnel (CEO, COO, Chief Compliance Officer, and Chief Investment Officer)

Interestingly, SEBI has done away with the requirement of appointing a Chief Risk Officer in both the routes.

There is also an option for a private equity fund or a pooled investment vehicle of a pooled investment fund to sponsor an MF lite. Private equity funds must go through the main investment route.

Private equity as sponsors:

• For private equity funds, the PE must either be a body corporate or a body corporate set up by a PE
• Only PE funds with experience of managing more than Rs. 2,500 crore AUM and over 5 years’ experience can become a sponsor
• Net worth and lock-in of Rs. 75 crore will be applicable for PE firms
• No off-market transactions allowed between AMC and sponsor-linked entities, i.e, investment companies where the PE has either more than 10% stake or has board rights or representation

Other key points for MF Lite includes:

• MF Lite schemes cannot:

  • Invest in bespoke or complex debt instruments, unlisted securities, or derivatives (except equity index rebalancing)

  • Undertake short selling or inter-scheme transactions

• AMC board should be held responsible for investor protection along with trustees

• If AUM crosses Rs.1 lakh crore, MF Lite AMC must comply with MF net worth regulations before launching new schemes or taking fresh subscriptions

• Sponsors managing both active and passive funds must ring-fence resources for passive funds such as infrastructure, technology and staff. However, support functions may be outsourced by the AMC

• Passive scheme track records can carry over to MF Lite AMCs if existing schemes are transferred

• Fast-track approvals for Scheme Information Documents (SIDs)

• Simplified SID and no separate Key Information Memorandum (KIM)

• Tracking Difference (TD) for equity passive schemes capped at 50 basis points

• Monthly disclosure of debt scheme portfolios and tracking error (TE) for equity is compulsory

• MF Lite Fund houses will have to create Unit Holder Protection Committees (UHPCs)

• Regular reporting to SEBI and trustees continues, including new metrics like Debt Index Replication Factor (DIRF)

• MF Lite AMCs must be structured as trusts registered under the Indian Registration Act