What the Sebi rules on passive funds mean for you

The market regulator recently issued a circular on passive funds covering issues related to transparency, liquidity and operational aspects of exchange-traded funds (ETFs) and index funds. These provisions will come into force on July 1. Mint decodes:

What is a passive ELSS scheme?

Passive funds mimic an underlying index. In contrast, active funds are actively managed by fund managers. The Securities and Exchange Board of India has now introduced a category of Equity Linked Passive Savings Schemes (ELSS), which will provide taxpayers with another investment option to avail tax benefits. According to the circular, the passive ELSS scheme will be based on any index composed of shares of the top 250 companies by market capitalization. From July 1, a fund house may have either an active ELSS scheme or a passive ELSS scheme, but not both.

What are the standards for debt ETFs?

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

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What about tracking error?

According to the Sebi circular, passive funds must disclose “tracking error” and “tracking difference” in their monthly information sheets. These measures indicate how much the fund’s performance differs from that of its underlying index, an effort to better inform investors. The circular specifies the tracking error and tracking difference limits that passive funds must comply with.

What is the NAV disclosure mandate?

Due to the low liquidity of ETFs in the secondary market in India, ETF prices may differ significantly from the net asset value (NAV) of the fund. The net asset value of the fund represents the value of the ETF’s underlying assets. The Sebi circular mandates the publication of the net asset value (indicative) continuously throughout the trading day. While the practice already exists, Sebi’s rules institutionalize it. Checking the net asset value can help avoid making a trade with a large premium or discount.

Can you directly execute ETF transactions?

Investors can only buy or sell ETF shares on a stock exchange. But, large buy or sell transactions can also be placed directly with the fund house. Sebi now says orders are over 25 crore alone can be placed for redemption or subscription directly with the Asset Management Company (AMC). This should direct trades up to this limit to exchanges and improve the liquidity of ETF shares. Nevertheless, there are a few other specified exceptions where ETF transactions can be made directly with the AMC.

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About Meredith Campagna

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