Sebi may widen 50% overlap rule to thematic passive mutual fund schemes

Curb on number of smart-beta schemes also likely; move aimed at curbing proliferation in segment

The Securities and Exchange Board of India (Sebi) is considering extending the maximum 50 per cent portfolio overlap rule — currently applicable to active funds — to index funds and exchange-traded funds (ETFs), in a move to curb the proliferation of schemes in the fast-growing passive mutual fund (MF) segment.

 

According to industry sources, the proposed restriction may initially apply only to sectoral and thematic passive schemes. Another major category within passive investing — smart-beta funds — could face limits on the number of schemes an asset management company (AMC) can launch.

 

“These are some of the suggestions made by the industry. The regulator may, however, choose a different approach,” said a senior mutual fund executive.

 

Queries sent to Sebi and the Association of Mutual Funds in India (Amfi) remained unanswered at the time of publication.

 

Earlier this year, Sebi introduced the 50 per cent overlap rule for active sectoral and thematic funds to prevent the launch of near-identical products. The regulator is exploring similar guardrails for the passive segment and had sought feedback from Amfi, according to another industry executive.

 

Over the past few years, new fund launches have increasingly been concentrated in the passive space as asset managers sought to gain market share in the rapidly expanding segment. The absence of launch restrictions, coupled with greater scope for product innovation, has led to a sharp rise in the number of offerings.

 

The number of passive schemes, including overseas products, has increased fivefold over the past six years. At 740, passive schemes account for nearly 40 per cent of all MF schemes, compared with just 8 per cent in April 2020.

 

The surge in launches has been accompanied by strong investor interest. Assets under management (AUM) in passive products, including gold and silver ETFs and overseas fund-of-funds, have grown ninefold since the pandemic to around ~15 trillion.

 

The proliferation of mutual fund schemes first came under Sebi's scrutiny in 2024, when fund launches hit record levels amid a strong equity market rally. That year saw more than 50 sectoral and thematic fund launches and around 130 passive fund launches.

 

Regulatory concerns were heightened by the concentration of launches in relatively narrow and higher-risk categories such as thematic and smart-beta funds, which were also attracting significant investor inflows.

 

New fund offers (NFOs) typically attract heightened investor interest during bull markets, with fund houses often launching products linked to sectors, themes or factors that have already delivered strong returns. This raises the risk of investors entering at or near the peak of a cycle and subsequently facing underperformance.

 

Since then, Sebi has rolled out several measures to keep the pace of new launches under check. Besides the overlap rule, the regulator has capped distributor commissions on switch transactions into NFOs and mandated time-bound deployment of NFO collections to address incentives that encourage frequent product launches.