Explainer- Lite-touch norms for passive funds

Explainer: Lite-touch norms for passive funds

Capital markets regulator Sebi has been mulling over relaxed regulations for fund houses that deal with passive-only funds. Sebi chief Madhabi Puri Buch recently said that the regulator’s target was to bring MF regulations down from 100 pages to just 10 pages, specific to passive funds. Siddhant Mishra takes a look at the likely impactPassive funds and the need for a relook at regulations

This category consists of those funds that do not have active fund managers, because the funds are benchmarked to an underlying index, and mimic the performance of the index. As a result, there is usually no churn in the portfolio by a fund manager, which is the case in actively managed schemes. Passive funds are low-fee and low-risk strategies, where the risk of underperformance gets minimised to a large extent.

Impact on industry

It is widely held that the proposal is with the intent to fuel innovation in the space, and ease launch of new products. The share of passive funds in the Rs 40-trillion industry stood at Rs 6.5 trillion as of February, as per ACE MF data. The data also shows that the passive industry has grown 40% in the last one year.

According to Siddharth Srivastava, head (ETF product) & fund manager at Mirae Asset MF, the move could boost participation in passive funds. Many regulations pertain to disclosures and costs applicable to active funds; so, relaxing those that may not be relevant to passive funds could help in faster launch of new fund offers (NFOs), and see the entry of new categories of investors. However, passive funds are not completely insulated from risks. Regulations pertaining to risk and compliance, Srivastava said, will stay intact and require strict adherence.

Likely relaxations

Among the relaxations being considered are the minimum net worth criterion for MFs, along with certain disclosure requirements. Existing norms mandate sponsors of MFs to have a net worth of at least Rs 150 crore. This includes a liquid net worth of Rs 100 crore, plus an additional Rs 50 crore to cover operational expenses of the fund house for the first five years, without support from the sponsor.

Another significant factor is that of costs incurred. The TER, or total expense ratio, pertains to various costs incurred by asset management companies (AMCs) for running and managing an MF scheme. These include sales and marketing or advertising expenses, administrative expenses, transaction costs, investment management fees, registrar fees, custodian fees, and audit fees — all as a percentage of daily net assets, as defined by AMFI.

The total expense ratio edge for some…

For the smaller sized AMCs, the permissible TER cap is upwards of 2% for equity and 2% for debt schemes. The CEO of an asset management firm said that the regulator clearly sees passive and active strategies as separate avenues, even if the norms governing them are the same.

He pointed out that the lack of a fund manager and churn in portfolios ensure passive funds are low-fee schemes, and when AMCs save on costs, it gives them more room to spend on active funds. As a result, those with a higher proportion of passive schemes could get an undue advantage as the TER saved on passive schemes could be diverted to active schemes without breaching the overall cap. With separate norms and caps on expenses, the regulator is probably trying to categorise passive funds as a separate class altogether, he added.

Passive funds usually consist of exchange-traded funds (ETFs), fund-of-funds (FOF), and index funds. These have widened over time to include gold and silver ETFs and FOFs, and overseas funds. These are defined as low-risk, but at the same time, returns generated are also on the lower side. Investors turn to passive funds usually during the time of intense volatility.