Sebi Tightens Oversight on Mutual Fund Portfolio Duplication
India's securities regulator is taking proactive measures to address portfolio overlap in mutual fund schemes. The Securities and Exchange Board of India (Sebi) is currently examining new fund offers with particular attention to how much they duplicate existing strategies within the same fund house.
Regulatory Scrutiny Intensifies
Sebi has begun asking mutual funds to provide model portfolios when filing for thematic new fund offers. The regulator specifically wants to understand the extent of overlap with the fund house's existing equity strategies. This scrutiny comes despite the fact that Sebi's draft proposals on overlapping stocks in mutual fund schemes have not yet been formally notified.
"Now, whenever a mutual fund files for a thematic NFO, Sebi is asking for a model portfolio and the extent of overlap with the fund house's existing equity strategies," revealed a person familiar with the matter who requested anonymity.
Another mutual fund executive confirmed this development, stating that when overlap appears excessive during NFO filings, Sebi questions the rationale behind launching another similar scheme.
The Overlap Problem in Focus
The issue of portfolio duplication has gained significance as thematic new fund offers help asset management companies expand their asset base. However, limited differentiation among schemes provides little value to investors. The growing number of such funds ultimately complicates investment choices rather than simplifying them.
Current regulations allow fund houses to launch one scheme in each category, but there is no cap on sectoral and thematic funds. This regulatory gap has led to a proliferation of similar offerings. Data from the Association of Mutual Funds in India shows that in the past year, there were 37 sectoral and thematic fund NFOs compared to only 19 NFOs across the entire equity category.
Evidence of Significant Overlap
Recent analysis examined the top five thematic funds by assets. Data from mutual fund research platform PrimeInvestor revealed that three out of these five thematic schemes had more than 50% overlap with a particular scheme in their own fund house. While overlap may exist across other AMC schemes as well, this limited analysis highlights the extent of the problem.
Sebi had previously noted significant portfolio overlap in the industry, stating that clear limits were necessary to prevent schemes from holding similar stocks. However, there has been no visible progress in the consultation process since the regulator's initial observations.
Industry Perspectives on Overlap Caps
Deepak Shenoy, chief executive officer of Capitalmind Mutual Fund, expressed reservations about generalizing caps on overlap in thematic or sectoral schemes. "It's difficult to generalize a cap on overlap in thematic or sectoral schemes, as two funds may overlap entirely by coincidence," he explained.
Shenoy pointed out that the financial sector forms a large part of the market, so many stocks may recur across different themes not by design but by coincidence. He suggested that such restrictions might not help investors and could potentially limit choice.
Proposed Regulatory Framework
Sebi's consultation paper, released on 18 July, proposed specific measures to address portfolio overlap. The regulator suggested that mutual funds ensure no more than 50% of stocks held in a sectoral or thematic scheme are the same as those held in other equity schemes within the same fund house, with the exception of large-cap schemes.
The paper also proposes allowing mutual funds to offer both value and contra funds, provided the portfolio overlap between the two does not exceed 50% at any point. This overlap would be monitored at the time of NFO deployment and subsequently on a semi-annual basis using month-end portfolios.
Compliance Requirements
If overlap exceeds permitted levels, asset management companies would need to rebalance portfolios within 30 business days. They could receive a possible extension of another 30 business days if approved by the investment committee. Should deviation continue beyond this period, investors would be given an exit option without any exit load.
"Since value and contra funds fall under the same category, it makes sense to have a cap on overlap," Shenoy commented regarding this specific proposal. "It expands opportunities for mutual funds, as current categorization norms allow a fund house to launch either a contra or a value fund. This proposal would allow mutual funds to offer both, provided the overlap is contained."
The regulatory scrutiny comes at a time when investors face increasing complexity in choosing among numerous similar-looking mutual fund schemes. While thematic NFOs continue to attract investor interest, questions remain about their genuine differentiation and value addition to investor portfolios.
