On the cusp of its next phase, the Securities and Exchange Board of India (SEBI) is taking steps to create a new asset class to fill a lacuna between the world of mutual funds (MFs) and the world of portfolio management services (PMS). This product will provide investors with a regulated investment product that enhances risk-taking capabilities and offers a significantly larger ticket size, a feature currently absent in the investment ecosystem, thereby addressing a clear market need.

The introduction of this new asset class will give investors the flexibility and options that they would otherwise have to look for elsewhere. SEBI has taken a segmented, risk-based approach to the regulation of investment products. This has resulted in a diverse range of products that are available for different categories of investors: retail, high-net-worth individuals (HNIs), and institutional investors. MFs, at one end of the spectrum, cater to retail investors with very low ticket sizes. At the other end, PMS and Alternative Investment Funds (AIFs) cater to HNI investors with very high minimum investment ticket sizes.

The PMS industry’s assets under management (AUM) have more than doubled over the last five years, while AIF assets saw a five-fold increase in the same period. The private credit market, which is a significant part of AIFs’ business now, has also seen tremendous traction, providing businesses with an alternative source of funding and generating attractive returns for investors. However, assessing the risks in private credit is often tricky, and some of these firms have controversially offered guaranteed returns, which could mislead investors about the real risk involved. This has inadvertently led investors to unregistered investment schemes that offer high returns without much regulatory safeguards.

The proposed new asset class aims to provide a regulated, structured investment product for investors who want to allocate a portion of their wealth to higher risk and return profiles without falling into the trap of dubious schemes. The new asset class will be offered as a mutual fund with relaxations in prudential norms to enable a higher degree of risk-taking with adequate safeguards.

The key features of this proposed asset are:

Higher minimum investment size: The minimum investment threshold will be set at ₹10 lakh per investor, so as to keep out retail investors and encourage those with significant investible surpluses.

Flexibility in portfolio construction: The new asset class will offer a higher level of flexibility in the construction of the portfolio, including the use of derivatives not only for hedging and portfolio rebalancing but for other purposes as well. The cumulative gross exposure through all the investable instruments, including derivatives, shall not exceed 100 per cent of the net assets of the investment strategy.

Distinct branding and nomenclature: To differentiate from traditional mutual funds and avoid brand contamination, the new asset class will have its own distinct branding, nomenclature (‘Investment Strategy’ is suggested), and advertising guidelines.

Regulatory oversight: All the SEBI regulations pertaining to mutual funds will apply to the new asset class, subject to such relaxations as may be deemed appropriate in view of product innovation. Thereby, regulatory oversight will be consistent and uniform across different asset classes of mutual funds.

AMC eligibility: AMCs with a track record or those meeting specific criteria will be eligible to offer products under this new asset class. The minimum criteria will be an operational period of three years and an average AUM of not less than ₹10,000 crore in the immediately preceding three years. Alternatively, they can appoint experienced fund managers.

Exposure to derivatives: The new asset class is allowed to take exposure to derivatives not only for hedging and portfolio rebalancing but also for other purposes as per existing SEBI provisions. The exposure through exchange-traded derivatives shall not exceed 50 per cent of the net assets of an investment strategy, and specific limits for single-stock derivatives shall also be provided.

Redemption and liquidity: The redemption frequency can be designed based on the nature of investments in the portfolio. AMCs may stipulate appropriate notice or settlement periods for redemptions to protect the interests of investors.

The addition of this new asset class will give investors access to an MF-PMS hybrid product, which will charge higher fees but provide higher returns while regulating the risk element of unregistered schemes. Also, the market will grow, product innovations will follow, and the volume of investments in this new asset class will be significant. However, there are risks too — higher risk exposure for investors as well as for SEBI, which has to walk a tightrope of robust oversight with the flexibility of a new asset class. Similar to mutual fund schemes, the investment strategies under the new asset class shall also be categorised under a risk-o-meter.

The new asset class will add a separate risk-return category for investors. It is a new category within mutual funds that, by its nature, is going to be riskier than traditional MFs but will also provide a regulated alternative to unregistered schemes. As SEBI does the consultations and fine-tunes the framework, the investment community will be watching keenly. Global experiences have been an important guidepost for SEBI’s initiative. For example, in the US, the development of liquid alternative funds or hedge fund lite structures has allowed retail investors access to hedge fund-like strategies with greater liquidity and regulatory oversight. These funds are offered under the Investment Company Act of 1940 and are regulated by the SEC, balancing high returns with investor protection.

In Australia, inverse ETFs and bear funds allow investors to profit from market declines, with sophisticated risk management tools available in a regulated framework. These global precedents show that innovative financial instruments can fill gaps in the investment universe and provide higher returns with effective safeguards.

The writer is Professor of Finance, IMT Ghaziabad

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