Understand MF Lite Framework Introduced by SEBI for Passive Funds

Last week, the Securities and Exchange Board of India (SEBI) introduced a new framework called Mutual Fund Lite or MF Lite. It aims to simplify the rules for managing passively managed mutual funds in India. The change is a positive move for companies looking to enter this space and also for investors. How? We will learn the details in this article.

What are passive funds?

Before we understand MF Lite, it is essential to learn about passive funds as it is for passive funds. Passive funds are investment vehicles that aim to replicate the performance of a specific market index, such as the Sensex or the Nifty 50. Unlike actively managed funds, which aim to outperform the market, passive funds simply seek to match the performance of their underlying index. Passive funds can be broken down into two sub-categories:

Index Funds: These are mutual funds that track a specific market index, such as the Nifty mid-cap index.
Exchange-Traded Funds (ETFs): ETFs are similar to index funds but trade on stock exchanges like individual stocks.

SEBI Introduces MF Lite Framework for Passive Funds to Ease Investing

Here are the details related to MF Lite:

1. Easier Access for New Players:

For new companies looking to enter this space, it reduces the entry barriers. Traditionally, starting a mutual fund company in India required meeting strict criteria, including a high net worth and a proven track record. This made it challenging for smaller or newer firms to enter the market. MF Lite has simplified this process, allowing more companies to offer passive investment products. This means investors have more choices and potentially lower fees.

2. Simplified role for trustees:

SEBI has streamlined the role of trustees for passive mutual funds. Previously, trustees had extensive oversight responsibilities, especially for actively managed funds. However, passive funds, which track market indices, require less oversight due to their simpler nature. This simplification means trustees can focus on key areas, reducing their administrative burden and compliance costs. This makes it easier for companies to manage passive fund schemes, potentially encouraging more players to enter the market.

3. Faster approval process:

SEBI has simplified the process for launching new passive mutual funds. Previously, companies faced lengthy approval procedures involving extensive documentation. Now, with MF Lite, the approval process is faster and less bureaucratic, allowing AMCs to introduce new passive funds more efficiently.

4. Options for existing asset management companies:

Existing asset management companies (AMCs) have a choice when it comes to their passive mutual funds:

Separate Entity: They can create a new separate company specifically for their passive funds. This allows them to take advantage of the simplified regulations for MF Lite.
Keep Together: They can continue managing their passive funds under their existing structure. Even in this case, they'll still benefit from the relaxed rules for passive funds.

Objectives of MF Lite Framework

MF Lite is introduced by SEBI with the following objectives:

Increase Competition: To promote competition in the mutual fund industry by reducing the barriers to entry for new players.
Offer Lower-Cost Products: To make passive investment products more accessible to investors by reducing the operational costs for fund houses.
Enhance Investor Choice: To provide investors with a wider range of investment options, especially low-cost passive funds.
Promote Financial Inclusion: To encourage financial inclusion by making investing more accessible to a broader range of individuals.
Streamline Regulatory Requirements: To simplify the regulatory framework for passive mutual funds, reducing the burden on fund houses.

The New Regulations of MF Lite in Phase 1

Private equity funds can now sponsor MF Lite schemes if they meet specific criteria, including a minimum of five years of experience and managing at least Rs 2,500 crore in committed capital. Asset Management Companies (AMCs) handling such schemes stand to benefit in multiple ways. These benefits include the mandatory three-year lock-in of the sponsor’s stake and conflict-of-interest safeguards, such as restrictions on off-market transactions between MF Lite schemes and their sponsors.

AMCs must also adhere to SEBI's net worth requirements. If an AMC's total Assets Under Management (AUM) exceed Rs 1 lakh crore, it must meet SEBI’s standard mutual fund regulations for net worth. Furthermore, the Association of Mutual Funds in India (AMFI), in collaboration with SEBI, will establish a standardized Investment Management Agreement specifically for the MF Lite framework.

Phase 1 Guidelines for MF Lite Framework

Phase 1 of the MF Lite framework focuses on passive investment schemes, introducing simplified regulatory processes for specific fund categories.

Domestic Equity Passive Funds

These funds track broad-based domestic equity indices like the Nifty 50 or Sensex or serve as benchmarks for actively managed funds. To qualify under the MF Lite framework, these funds must collectively manage an AUM of at least Rs 5,000 crore as of December 31 of the financial year. AMFI, in consultation with SEBI, will periodically update the list of eligible domestic equity indices.

Domestic Debt Passive Funds

This category includes:

Funds investing in government securities (G-Secs), treasury bills (T-Bills), and state development loans (SDLs).
Funds based on constant duration passive debt indices.

These funds also require a minimum AUM of Rs 5,000 crore as of December 31 annually.

Gold and Silver ETFs

Gold and silver ETFs, along with funds of funds (FoFs) that exclusively invest in these ETFs, are eligible. These funds aim to provide investors with a cost-effective way to gain exposure to precious metals.

Overseas ETFs and FoFs

ETFs and FoFs investing in a single overseas passive fund can be part of Phase 1, provided their benchmarks comply with MF Lite requirements. Similarly, FoFs investing exclusively in a single domestic or overseas index are eligible. However, FoFs that invest in multiple indices are excluded from Phase 1.

Overseas Equity Passive Schemes

For overseas equity schemes, the framework mandates:

Tracking broad-based, standardized indices.
A minimum of 10 securities in their equity index portfolio.
Eligibility is limited to indices with a minimum AUM of $20 billion as of December 31 of each year.

How will MF lite be beneficial for investors?

Let us now look at different ways through which MF Lite will benefit the investors;

Lower Costs: MF Lite funds are likely to have lower expense ratios than traditional mutual funds. It means investors pay less in fees, leading to higher returns over the long term.
Greater Accessibility: The relaxed entry requirements for MF Lite funds make it easier for smaller asset management companies to launch new products. It increases the variety of investment options available to investors.
Simplified Investment Process: MF Lite funds will require less documentation and paperwork, making it easier for investors to invest.
Potential for Higher Returns: Lower expense ratios can lead to higher returns for investors over the long term.

Before you go

Overall, MF Lite is a positive development for Indian investors seeking low-cost, diversified investment options. By providing a more streamlined and efficient framework, MF Lite can help investors achieve their financial goals.