Capital Markets: Challenges and Developments

Understanding SEBI Rules on Passive Funds

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Passive Funds

Mains level : Not Much

The Securities and Exchange Board of India (SEBI) recently issued a circular on passive funds covering matters related to transparency, liquidity and operational aspects of exchange-traded funds (ETFs) and index funds.

What are Passive Funds?

  • A passive fund is an investment vehicle that tracks a market index, or a specific market segment, to determine what to invest in.
  • Unlike with an active fund, the fund manager does not decide what securities the fund takes on.
  • This normally makes passive funds cheaper to invest in than active funds, which require the fund manager to spend time researching and analysing opportunities to invest in.
  • Tracker funds, such as ETFs (exchange traded funds) and index funds fall under the banner of passive funds.

What is a passive ELSS scheme?

  • Passive funds mimic an underlying index. By contrast active funds are actively managed by fund managers.
  • The SEBI has now introduced a passive equity-linked saving schemes (ELSS) category, which will give taxpayers another investment option to avail of tax benefits.
  • According to the circular, the passive ELSS scheme will be based on any index comprising equity shares from the top 250 companies in terms of market capitalization.
  • Beginning 1 July, a fund house will be able to either have an active ELSS scheme or a passive ELSS scheme, but not both.

What are the norms for debt ETFs?

  • Passive debt funds are now divided into three categories:
  1. Corporate debt funds with exposure to corporate bonds
  2. G-Sec funds investing in government securities, and
  3. Hybrid funds where allocation is a combination of corporate bonds and government securities
  • Currently, debt funds in the passive category invest only in AAA-rated instruments.
  • The Sebi circular introduces norms for each debt fund category, including portfolio exposure limits to each sector, the issuer (based on rating) and group.
  • Application of these provisions should help mitigate concentration risk in debt ETFs/ index funds.

What about tracking error?

  • As per Sebi’s circular, passive funds must disclose ‘tracking error’ and ‘tracking difference’ in their monthly fact sheets.
  • These metrics indicate how different the performance of the fund is compared to its underlying index—an effort to keep investors better informed.
  • The circular specifies limits for tracking error and tracking difference, which passive funds must follow.

What is the mandate on disclosing NAVs?

  • Because of poor liquidity for ETFs in the secondary market in India, ETF prices could differ widely from the net asset value (NAV) of the fund.
  • The NAV of the fund represents the value of the underlying asset of the ETF.
  • The Sebi circular mandates disclosure of NAV (indicative) on a continuous basis throughout the day on the stock exchange.
  • While the practice is already in existence, Sebi rules institutionalize it.
  • Checking the NAV can help one avoid making a transaction at a significant premium or discount.

Can one execute ETF transactions directly?

  • Investors can buy or sell units of ETFs only on stock exchanges.
  • But, large buy or sell transactions can also be directly placed with the fund house.
  • Sebi now says orders greater than ₹25 crore alone can be placed for redemption or subscription directly with the asset management company (AMC).

 

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Subscribe
Notify of
0 Comments
Inline Feedbacks
View all comments