Overseas Mutual Funds’ Investments And Clearer Disclosures: SEBI’s New Guidelines For Mutual Funds

Posted On - 19 November, 2024 • By - Aurelia Menezes

Introduction

The Securities and Exchange Board of India (SEBI) has recently issued two circulars aimed at improving transparency and investor understanding within the Mutual Fund industry. These circulars address two key areas: investments in overseas Mutual Funds/Unit Trusts (MF/UTs) and disclosure practices for domestic Mutual Fund schemes.

The first circular, dated 4^th November 2024, focuses on streamlining investments in overseas MF/UTs by Indian Mutual Funds.[1] This move caters to investor demand for diversification and facilitates easier access to these overseas funds. The circular outlines specific regulations to ensure transparency in the investment process.

The second circular, dated 5^th November, 2024 addresses the way Mutual Funds disclose information about their schemes.[2] The focus here is on enhancing clarity and standardization. The circular mandates separate disclosures for direct and regular plan options of a scheme, including expenses, returns, and yield. Additionally, it introduces a color scheme for the existing Risk-o-meter, a visual tool that communicates the risk profile of a Mutual Fund scheme. This standardization will simplify investor comprehension and allow for easier comparison between different schemes.

Taken together, these circulars demonstrate SEBI’s commitment to fostering a more informed and transparent investment environment for Mutual Fund investors in India. By regulating overseas investments and standardizing disclosures, SEBI aims to empower investors to make well-considered investment decisions.

Indian Mutual Funds Investing in Overseas Mutual Funds/ Unit Trusts

This Master Circular permits Indian Mutual Funds to invest in overseas MF/UTs under certain conditions to ease overseas investment processes, ensure transparency, and enable diversification.

Permissible Investments

Indian Mutual Funds may invest in overseas securities, including MF/UTs with exposure to Indian securities.
The exposure of these overseas MF/UTs to Indian securities should not exceed 25% of their total assets.

Conditions for Investment in Overseas MF/UTs with Indian Exposure

Pooling of Investments: Contributions from all investors must be pooled into a single investment vehicle without side vehicles like segregated portfolios or protected cells.
Common Portfolio (Blind Pool): The corpus of the overseas MF/UT should be a common portfolio, where all investors have pari-passu and pro-rata rights, receiving returns proportional to their contributions.
Independent Fund Management: The MF/UT must be managed by an independent investment manager who autonomously makes investment decisions, free from investor influence.
Public Disclosure: Overseas MF/UTs must disclose their portfolios publicly at least quarterly to ensure transparency.
No Advisory Agreements: There should be no advisory agreements between Indian Mutual Funds and the underlying overseas MF/UTs, avoiding conflicts of interest.

Monitoring of Indian Securities Exposure Limit

At the time of both fresh and subsequent investments, Indian Mutual Funds should confirm that the overseas MF/UT does not exceed 25% exposure to Indian securities.
If, post-investment, the exposure limit of 25% is breached, a 6-month observance period is allowed for the underlying MF/UT to rebalance its portfolio.

Observance Period Guidelines

During this period:

Indian Mutual Funds cannot make fresh investments in the MF/UT that breached the limit.
Investment may resume only if the MF/UT rebalances its portfolio within the limit.

Rebalancing and Liquidation Period

If rebalancing is not achieved within the 6-month observance period, Indian Mutual Funds must liquidate their investment in the overseas MF/UT within the following 6-month liquidation period.
If the exposure falls back within the 25% limit during the liquidation period, liquidation is not required.

Consequences of Non-Compliance

If Indian Mutual Funds fail to comply with these requirements after the liquidation period, SEBI will impose the following restrictions:

No acceptance of new subscriptions in the concerned Mutual Fund scheme.
Prohibition on launching any new schemes.
No exit load can be charged on investors exiting the scheme.

Exemption from Fundamental Attribute Change

If the underlying overseas MF/UT surpasses the 25% exposure to Indian securities and the Indian Mutual Fund scheme decides to reinvest in another overseas MF/UT with similar objectives, it is exempt from the requirement for a fundamental attribute change.
This exemption is conditional upon:
- Issuing a notice and addendum to investors.
- Ensuring that the new MF/UT aligns with the original investment objectives.

Enhanced Disclosures and Risk-o-Meter Color Scheme for Mutual Funds

SEBI has mandated various disclosures to enhance transparency, improve investor comprehension, and standardize mutual fund industry practices. This initiative is based on recommendations from the Mutual Fund Advisory Committee. The provisions in this SEBI circular are set to take effect on December 05, 2024.

Disclosure of Expenses, Half-Yearly Returns, and Yield

Direct vs. Regular Plan:
- The direct plan was introduced in 2012 and does not involve distribution expenses or commissions, resulting in lower expense ratios than regular plans.
- Consequently, returns on direct plans are often higher compared to regular plans.
Detailed Disclosure Requirements:
- Expenses: Disclose total recurring expenses separately for both direct and regular plans as per SEBI (Mutual Funds) Regulations, 1996 (Regulation 59 and Twelfth Schedule).[3]
- Returns: Disclose half-yearly returns and compounded annualized yields separately for direct and regular plans.
- Format Standardization: The Association of Mutual Funds in India (AMFI)[4], in consultation with SEBI, will review and finalize the format for half-yearly financial statements of mutual fund schemes.
- Additional Disclosures: For all regulatory disclosures involving expenses, expense ratios, returns, and/or yield, separate disclosures for direct and regular plans are required.

Risk-O-Meter Colour Scheme

Product Labeling:
- SEBI’s Master Circular (June 27, 2024) specifies levels of risk as Low, Low to Moderate, Moderate, Moderately High, High, and Very High.
- New color scheme for risk levels introduced for clarity and visibility in digital and printed promotional materials:
  - Low Risk – Irish Green [#08A04B]
  - Low to Moderate Risk – Chartreuse [#7FFF00]
  - Moderate Risk – Neon Yellow [#FFFF33]
  - Moderately High Risk – Caramel [#C68E17]
  - High Risk – Dark Orange [#FF8C00]
  - Very High Risk – Red [#F70D1A]
Risk Level Communication: Each mutual fund scheme must display its risk level using the color-coded risk-o-meter on all promotional materials.

Disclosure of Changes in Risk-O-Meter

Unitholder Communication:

Any change in the risk level of a scheme is communicated to unitholders via Notice cum Addendum, email, or SMS.
The new disclosure format will show both the existing and revised risk levels for easier understanding of risk changes.

Conclusion

In recent updates, SEBI’s dual circulars reveal a focused approach to refining the investment landscape within India’s Mutual Fund industry, aiming to bring clarity and protection to investors. By enabling Indian Mutual Funds to invest in overseas funds under controlled conditions, SEBI seeks to empower investors with greater diversification opportunities while ensuring that such investments maintain transparency and uphold investor rights. The inclusion of a stringent 25% exposure limit on Indian securities for overseas funds, along with observance and liquidation periods, is a balanced method of mitigating risk without stifling the diversification benefit.

On the domestic front, the mandated disclosures of expenses, returns, and yields for direct and regular plans, along with the new color-coded Risk-o-Meter, bring a new level of transparency and ease of comprehension to investors. These updates ensure that investors are better informed about the cost and risk levels of their chosen Mutual Funds, making it simpler to compare schemes and evaluate risks independently. By fostering an environment where information is accessible and risks are communicated, SEBI strengthens investor confidence, empowering individuals to make educated and transparent investment choices within the evolving Mutual Fund landscape.

[1] https://www.sebi.gov.in/legal/circulars/nov-2024/investments-in-overseas-mutual-funds-unit-trusts-by-indian-mutual-funds_88198.html.

[2] https://www.sebi.gov.in/legal/circulars/nov-2024/disclosure-of-expenses-half-yearly-returns-yield-and-risk-o-meter-of-schemes-of-mutual-funds_88230.html.

[3] https://www.sebi.gov.in/sebi_data/commondocs/mutualfundupdated06may2014.pdf.

[4] https://www.amfiindia.com/

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