Diversification means many things for mutual funds (MFs). They swear by diversification when it comes to investing in the equity and debt markets. But did you know that it’s not just investments that MFs are mandated to diversify across? The capital market regulator, Securities and Exchange Board of India (Sebi), mandates that all MF schemes should have at least 20 investors and no investor should hold more than 25% of the scheme’s corpus. This norm is more popularly known as the 20-25 norm.
Just diversifying across investments is not enough. There’s a reason why MFs needs to diversify across investors, too. This is to ensure that no single investor owns a large pie of the scheme. In case a single investor holds a large portion, it could create havoc if the investor suddenly decides to withdraw. The MF would need to sell its most liquid assets—typically they would also be among the best scrips in the portfolio—to generate enough cash to pay the large investor. Existing investors stand to lose if the fund has to sell its best assets at throwaway prices to generate emergency cash.
As per Sebi’s mandate, all fund houses are mandated to publish details of single large investors as part of their half-yearly scheme disclosures. Earlier, you could find instances of schemes having large single investors, typically one or two, holding large chunks to the extent of 70-90% of a single scheme. In a circular that Sebi issued in December 2003, it imposed the 20-25 norm. A new fund offer is given a three-month leeway to comply with this norm, failing which it must redeem the money to its existing investors and the scheme is to be wound up.
In 2005, Sebi modified its stance and reiterated that the 20-25 norm has to be implemented on a portfolio level. This means that if a single, say, liquid fund has two dividend and growth options but has a common portfolio, then the corpus of the entire scheme would be accounted for to figure out any single investor holding. Earlier, both dividend and the growth individually had to comply with the 20-25 norm. Also, the earlier norm made it mandatory for schemes to be wound up if the 20-25 norm was flouted. In 2005, this changed—it became mandatory for MFs to either accept fresh money to bring the share of the large investor down or redeem the excess amount to large investors. MFs are mandated to monitor this every quarter.