The Securities Exchange Board of India’s (SEBI) idea of a wholly new product category, sandwiched between mutual funds and portfolio management schemes (PMS), seems to be aimed at weaning retail investors away from risky products such as derivatives and unregulated portfolio managers. It may also open up a new growth avenue for asset management companies (AMCs), many of whom have exhausted the 36-category menu of permitted funds. AMCs will be allowed to launch a separate vertical with new high-risk strategies for retail investors. The minimum investment will be ₹10 lakh, compared to the ₹500 entry ticket for mutual funds, and ₹50 lakh threshold for PMS.

SEBI proposes to allow managers of this new vehicle to experiment with naked exposure to derivatives, long-short strategies, inverse funds, lower-rated bonds and other risky strategies, which are untested and expressly forbidden to mutual funds. Therefore, it appears to be prudent to allow these launches only by AMCs which have built up a credible track record of creating retail wealth. The requirement that the new products only be offered by AMCs with a 3-year record of managing ₹10,000 crore, with no regulatory issues, makes sense. But SEBI has also suggested that new players who don’t meet the above criteria, hire a Chief Investment Officer and fund manager with requisite experience.

This seems avoidable given that the sponsor’s pedigree and track record are critical to good governance. PMS and Alternative Investment Fund (AIFs) managers are bound to feel aggrieved that they haven’t been allowed to lower their ticket sizes to cater to this market. But they offer customised products to HNIs and enjoy light-touch regulations, while the new product will follow a pooled structure which will be subject to SEBI’s onerous mutual fund regulations. SEBI also proposes to vet all offer documents for new launches and strategies under this vertical. Nevertheless, granular aspects of regulating this new category need fleshing out. Given that these products will dabble in non-traditional assets such as derivatives, they will require different valuation, accounting, disclosure and risk management rules compared to mutual funds. AMCs will also need to build internal capacity to offer these schemes. Whether this will be possible under SEBI’s extant expense limits for mutual funds, is moot.

Both the regulator and AMCs should be prepared for a long journey before this new category is well-understood. It has after all taken over three decades for the mutual fund industry and its regulations to attain their current mature state. It is all too easy for retail folk to over-estimate their risk appetite and clamour for sophisticated products when the markets are on song. The real test will come when markets deliver losses. Even if this consultation paper finds widespread acceptance, SEBI must take its time to flesh out the regulation and risk disclosures, before rolling out this product.

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