SEBI allows MFs to launch passively managed ELSS schemes. All you need to know

In a significant step forward for index investing in India, the capital markets regulator has allowed mutual funds to launch equity-linked savings schemes (ELSS) as passively managed funds. 

The Securities and Exchange Board of India (SEBI) wants such passively managed ELSS schemes to be based on an index that comprises the top 250 companies in market capitalization terms. 

The regulator also set investment limits for debt exchange-traded funds and index funds as well as norms for market makers.

But first, what are ELSS schemes? 

ELSS schemes allow equity investors to get the benefits of income tax exemptions under section 80C of the Indian income tax act, much like those investors putting their money into the public provident fund, the employee provident fund, the National Pension Scheme, tax-saver fixed deposit schemes and several other options that allow a limited tax exemption. 

So, is there any restriction on how many or what sort of schemes can a mutual fund manage?

Yes, SEBI has put a caveat. A mutual fund can have either an actively-managed ELSS scheme or a passively-managed one, but not both.

Apart from ELSS, what other guidelines did SEBI lay down?

SEBI has also laid down guidelines on how passive debt funds – exchange traded funds (ETFs) and index funds – should be managed and set investment limits for such funds.

But how will these guidelines help?

The market regulator thinks that these guidelines would ensure that the passive fund replicates a diversified underlying index.

What other investor friendly guidelines has the market regulator given?

SEBI has prescribed that only transactions above Rs 25 crore can be done directly with the asset management company (AMC), where the investor places an order for creation or redemption of ETFs units with the AMC.

To ensure liquidity of the ETFs on the stock exchanges, the mutual funds would be required to appoint at least two market makers, who are members of the stock exchanges.

If there are any incentives to be given to the market makers, it should be charged to the scheme within the stipulated limit of total expense ratios (TERs).

SEBI wants mutual funds to have a transparent incentive structure in place for market makers. These incentives will be linked to the performance of market markets in terms of generating liquidity for the ETFs.

Also, fund of funds (FoFs) investing more than 80% of their NAV in underlying domestic passive funds, will not be required to set aside funds for investor awareness.

To make new fund launches for debt exchange traded funds (ETFs) and Index Funds easier, the minimum subscription amount in such a new fund offer (NFO) has been reduced from Rs 10 crore to Rs 5 crore.

Also, if the index constituents change due to periodic review, the portfolio of debt ETFs and debt index funds should be re-balanced within seven calendar days. In case the rating of any security is downgraded to below the rating criteria of the index (including downgrade to below investment grade), the portfolio should be rebalanced within 30 days, SEBI said.