SEBI's New Asset Class: One More Avenue for Risk Takers

To fix this gap, the Board of the capital market regulator, the Securities and Exchange Board of India (SEBI) on Monday cleared the proposal for introduction of a new investment product in the country.

This new asset class will be referred to as ‘Investment Strategies’ under the existing Mutual Fund framework. The proposal follows a consultation paper that was floated in July.

With the new asset class, the regulator wants to offer avenues for investors that have higher risk-taking capabilities than the average.

The risk-return profile of the proposed new asset class will lie between mutual funds and portfolio management services (PMS) that are offered by asset management companies (AMCs) and stock broking companies. 

The Need For A New Product Category

Today, one can invest in a mutual fund with an investment amount of as little as Rs 100 through a systematic investment plan (SIP) and with an amount of Rs 50 lakh and Rs 1 crore for PMS and AIF respectively.

However, a need was felt to fill the gap between MFs and PMS by offering a regulated product featuring greater flexibility, higher risk-taking capability, and a reasonable ticket size, to meet the needs of the emerging category of investors.

The proposed new asset class will have a ticket size of Rs 10 lakh per investor per AMC.

There are other reasons too. "The new product also aims to curtail the proliferation of unregistered and unauthorized investment schemes/entities, which often promise unrealistic high returns and exploit investors’ expectations for better yields, leading to potential financial risks," SEBI said in a press release on Monday.

What's On Offer - Portfolio Flexibility, New Strategies

The new asset class will have a distinct nomenclature from traditional mutual funds (MFs) and other investment products that are already available in the securities market such as PMS, AIF, Real Estate Investment Trusts (REITs), INVITs etc. The new product will be referred to as ‘Investment Strategies’.

Flexibility in portfolio construction: Besides a higher ticket size of Rs 10 lakh per investor per AMC, one biggest unique selling proposition of the new product is how the portfolio would be constructed. Higher risk-taking than MFs would be allowed.

While the new asset class will be able to invest in all the investments permissible to MFs, they shall be allowed to take exposure in derivatives for purposes other than hedging and portfolio rebalancing.

This implies that they can take speculative exposure in derivates, unlike MFs to the extent of 25 per cent of the asset under management.

Long-short strategy: Although details for the new product are yet to be released by the regulator, the consultation paper has hinted that the new asset class will be able to undertake investment strategies including long-short equity strategy and inverse Exchange-traded Fund (ETF) strategy.

While the former involves taking long and short positions in equity and equity-related instruments, the latter aims to generate returns negatively correlated with the underlying index by use of derivative products.

This will let investors hedge against market downturns or speculate on market declines.

To point out, currently fund managers in India are not allowed to take up such strategies which are prevalent in the US and Australian markets.

Regulation & Safeguards

Like other asset classes, SEBI will regulate the new investment product.

Adequate disclosure about the portfolio and strategy undertaken will have to be made periodically for new asset classes by the entity offering such products. Finer details are awaited.

"The new product aims to provide investors with a professionally managed and well-regulated product that offers greater flexibility, higher risk-taking capabilities for higher ticket size, while ensuring that appropriate safeguards and risk mitigation measures are in place," said the regulator the press release.

To ensure safeguards, no investment in unlisted and unrated instruments beyond those already permitted for mutual funds would be allowed for the new asset class.

Further, they will not be allowed to borrow for the purpose of investments except to meet temporary liquidity needs. Investments in debt securities will be restricted too.

Finally - Cannibalising The PMS market?

While the new asset class is expected to bring innovative investment products and styles in the market, some churning can be expected. Some fear that, PMS and AIFs could lose investors to the new asset class.

Some investors could move from existing high-risk products like PMS and AIFs to the new asset class. Thus, PMS and AIF may get disadvantaged with a fall in their AUM in favour of the new asset class.

While it remains to be seen if this materializes, the industry is awaiting nitty-gritties like expense ratio, distributor payout mechanism, and tax treatment for the new asset class.

If set appropriately, the new product can add depth and variety to the investment landscape in the country.

(The author is a Mumbai-based analyst and researcher. Views expressed are personal)