The Securities and Exchange Board of India (“SEBI”) has issued a draft circular titled “Categorization and Rationalization of Mutual Fund Schemes” for public comments. The circular is addressed to all mutual funds, asset management companies (“AMCs”), trustee companies, and the Association of Mutual Funds in India (AMFI).
This draft builds upon SEBI’s earlier circulars dated October 6, 2017, and November 6, 2020, which had introduced a standardized framework for categorizing mutual fund schemes. The objective of those circulars was to ensure uniformity across scheme characteristics, improve comparability, and enhance investor understanding. Since the issuance of those circulars, the mutual fund industry has seen significant growth in assets under management (“AUM”) and investor participation. Alongside this growth, investor preferences have evolved, asset allocation strategies have diversified, and new investment avenues such as Real Estate Investment Trusts (“REITs”) and Infrastructure Investment Trusts (“InvITs”) have emerged.
In view of these developments, and based on industry representations, SEBI has undertaken a review of the existing framework. The aim is to allow greater flexibility for product innovation, while maintaining investor protection and clarity in scheme positioning. SEBI has also noted the issue of portfolio overlap across schemes with similar investment profiles. In certain cases, there was a significant similarity in portfolios, prompting the need for clearer boundaries and operational limits to reduce such overlaps.
Accordingly, the draft circular revises specific provisions within the five existing scheme categories. These changes are intended to address observed overlaps, introduce operational clarity, and support the introduction of new schemes within the defined categorization structure.
Proposals Through the Draft Circular
SEBI has invited public comments on proposals relating to various scheme categories. These proposals are summarised below.
A. Equity Schemes
SEBI proposes allowing mutual funds to offer both Value and Contra Funds within the equity category, provided the overlap between their portfolios does not exceed 50 percent. This condition would be monitored at the time of new fund offer (NFO) deployment and on a semi-annual basis using month-end portfolios. In case of non-compliance, AMCs would be required to rebalance portfolios within 30 business days, with a possible extension of an additional 30 business days subject to Investment Committee approval.
In the case of thematic and sectoral funds, SEBI proposes capping overlap with other equity schemes in the same category at 50 percent, excluding large cap schemes. Existing schemes in this category would be required to align with this requirement within one year from the date of the circular.
SEBI also proposes that mutual funds may invest the residual portion of their equity category schemes in debt instruments (including money market instruments), gold and silver instruments, and units of REITs and InvITs, subject to existing regulatory limits.
B. Debt Schemes
In the debt category, SEBI proposes replacing the term “Duration” with “Term” in the scheme name to improve investor understanding. For example, a Medium Term Fund would replace a “Medium Duration Fund.” Additionally, SEBI has suggested renaming the “Low Duration Fund” as the “Ultra Short to Short Term Fund” to more accurately reflect its investment objective.
Another proposal is to explicitly include the portfolio maturity duration in the scheme name, such as “Overnight Fund (1 Day)” or “Medium Term Fund (3 to 4 Years).”
SEBI also proposes that mutual funds may be allowed to invest the residual portion of their debt category schemes in REITs and InvITs, except in schemes with shorter durations such as Overnight, Liquid, Ultra-Short Duration, and Money Market Funds.
Regarding sectoral debt schemes, SEBI proposes allowing AMCs to launch such funds, provided no more than 60 percent of their portfolios overlap with any other sectoral debt scheme/ debt category scheme. These funds would be exempt from existing sectoral exposure limits under the Master Circular, subject to adequate availability of investment-grade paper in the selected sector.
C. Hybrid Schemes
SEBI proposes that Arbitrage Funds be permitted to invest only in government securities with a maturity of less than one year and repos backed by government bonds.
In the Equity Savings category, SEBI suggests mandating that the net equity exposure and arbitrage exposure fall within a range of 15 to 40 percent. Schemes would also need to disclose the minimum hedged and unhedged exposures in their Scheme Information Documents (SIDs).
Another proposal allows hybrid category schemes, except Dynamic Asset Allocation and Arbitrage Funds, to invest the residual portion of their portfolio in REITs and InvITs, subject to applicable ceilings.
D. Solution Oriented Schemes
SEBI has proposed allowing mutual funds to offer additional scheme variants within the Retirement and Children’s Fund categories that differ in their equity-debt allocation mix, within the specified ranges. These include: Retirement Funds (equity, hybrid and debt) andChildren’s Fund (equity, hybrid and debt).
Another proposal allows investment of the residual portion of solution-oriented schemes in REITs and InvITs, except for Retirement Fund – Hybrid and Children’s Fund – Hybrid, subject to regulatory limits.
E. Other Schemes
SEBI has also proposed a new structure for Life Cycle Fund of Funds (“FoFs”), which would allocate investments to equity, hybrid, and debt funds based on a target maturity date. These funds may be launched every five years with a maximum tenure of 30 years and may be merged into shorter maturity funds with investor consent.
Further, SEBI has proposed permitting Life Cycle FoFs with lock-in periods targeted at specific life goals such as housing or marriage, and allowing flexibility in choosing lock-in periods of 3, 5, or 10 years, based on the goal.
In addition to the above proposals, SEBI proposes permitting mutual funds to offer additional schemes within an existing category, subject to conditions such as a five-year track record and an AUM exceeding Rs. 50,000 crore. These additional schemes must follow the same investment objective and broad features, but may appoint separate fund managers. Upon the launch of such a scheme, the existing scheme would stop accepting subscriptions.
SEBI has also suggested changing the term “Fund” to “Scheme” in the scheme name, for example, using “Large Cap Scheme” instead of “Large Cap Fund.”
Our view:
SEBI’s proposals reflect a balanced approach that promotes innovation while maintaining investor clarity. By allowing additional schemes within existing categories, subject to AUM and track record thresholds, the framework offers established AMCs the flexibility to introduce new offerings without diluting regulatory safeguards. The proposed cap on portfolio overlaps, such as the 50 percent limit between Value and Contra Funds or thematic schemes, is a step towards improving scheme differentiation and ensuring greater transparency for investors.
At the same time, these overlap restrictions introduce operational demands. Monitoring compliance on a semi-annual basis and rebalancing within fixed timelines may increase administrative burden for AMCs and lead to portfolio distortions driven by regulatory timelines rather than investment rationale.
The introduction of Life Cycle FoFs with goal-specific lock-ins is a welcome move to support disciplined, long-term investing tailored to life milestones. Similarly, the proposal to permit sectoral debt funds with up to 60 percent portfolio overlap is a forward-looking step that encourages product innovation. However, its viability depends on the availability of sufficient high-grade instruments within individual sectors. Without adequate market depth, these funds could face liquidity pressures and heightened concentration risk, particularly in periods of low investor participation.
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