Mutual funds likely to get nod to invest in ETFs with India presence

India exposure in such global ETFs could be capped at 20%

The Securities and Exchange Board of India (SEBI) is considering allowing domestic mutual funds (MFs) to invest in overseas exchange-traded funds (ETFs) with an Indian exposure. Currently, Indian MFs invest in a variety of global ETFs via the fund-of-fund (FoF) route, but these funds typically invest solely in overseas securities amid ambiguity over whether they can have any Indian presence.

The Securities and Exchange Board of India (Sebi’s) proposal, if implemented, would permit FoFs to track popular benchmarks, such as the Emerging Market (EM) index and the JP Morgan EM Opportunities Fund. However, the markets regulator has stipulated that the Indian exposure in these funds must be capped at 20 per cent.

“Ambiguity regarding investments in such overseas funds that may invest a certain portion of their funds in Indian securities deters MFs from investing in those overseas MFs, ETFs, and index funds that invest in a basket of countries, which may include India,” said Sebi in a consultation paper floated on Friday. Public comments have been sought until June 7.

At present, domestic MFs can invest in overseas shares and assets, subject to an industry-wide limit of $7 billion. The industry has already exhausted the permissible limit.

Sebi has stated that if India’s weighting in global ETF exceeds the 20 per cent mark, Indian MFs will have to wait for six months for any rebalancing to occur. If the exposure doesn't decrease in this period, then Indian MFs will have to liquidate their investment in such an overseas fund within the next six months.

“To strike a balance between facilitating investments in overseas funds with exposure to India and preventing excessive exposure, a limit of 20 per cent is deemed appropriate," it said. If the fund doesn't liquidate within the six-month period, it will face restrictions on fresh subscriptions, new scheme launches, and levying exit load.

The MSCI EM index, with assets of $85 billion, is a popular benchmark among global investors seeking exposure to the emerging market asset class with countries/regions, such as China, India, South Korea, Taiwan, and Brazil. After the latest rebalancing, India's weighting in the MSCI EM index is set to increase to 19 per cent.

Industry players suggest that the implementation of the proposal could lead to a surge in domestic MFs launching FoFs on the MSCI EM index. However, regulators, primarily the Reserve Bank of India (RBI), will first have to increase the overseas investment limit for mutual funds to invest in overseas assets, they explain.

Among the conditions, Sebi has suggested that it must ensure that there is no advisory agreement between the Indian MFs and the underlying overseas fund to prevent any undue advantage or conflict of interest. Furthermore, the overseas mutual fund must also have an independent investment manager actively involved in decision-making.

Stepping forward

> Domestic mutual funds may be allowed to invest in foreign funds with India exposure

> Industry players say need relaxation on the threshold to benefit from the Sebi proposal

> Fund of funds will be able to track global benchmarks like MSCI Emerging Market Index, JP Morgan EM Opportunities Fund

> Indian MFs have exhausted $7 billion limit for overseas investments