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Home / Markets / Stock Markets /  Understanding the Sebi rules on passive funds

The market regulator recently issued a circular on passive funds covering matters related to transparency, liquidity and operational aspects of exchange-traded funds (ETFs) and index funds. These provisions will come into effect from 1 July. Mint decodes:

What is a passive ELSS scheme?

Passive funds mimic an underlying index. By contrast active funds are actively managed by fund managers. The Securities and Exchange Board of India has now introduced a passive equity-linked saving schemes (ELSS) category, which will give taxpayers another investment option to avail of tax benefits. According to the circular, the passive ELSS scheme will be based on any index comprising equity shares from the top 250 companies in terms of market capitalization. Beginning 1 July, a fund house will be able to either have an active ELSS scheme or a passive ELSS scheme, but not both.

What are the norms for debt ETFs?

Passive debt funds are now divided into three categories—corporate debt funds with exposure to corporate bonds, G-Sec funds investing in government securities, and hybrid funds where allocation is a combination of corporate bonds and government securities. Currently, debt funds in the passive category invest only in AAA-rated instruments. The Sebi circular introduces norms for each debt fund category, including portfolio exposure limits to each sector, the issuer (based on rating) and group. Application of these provisions should help mitigate concentration risk in debt ETFs/ index funds.

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What about tracking error?

As per Sebi’s circular, passive funds must disclose ‘tracking error’ and ‘tracking difference’ in their monthly fact sheets. These metrics indicate how different the performance of the fund is compared to its underlying index—an effort to keep investors better informed. The circular specifies limits for tracking error and tracking difference, which passive funds must follow.

What is the mandate on disclosing NAVs?

Because of poor liquidity for ETFs in the secondary market in India, ETF prices could differ widely from the net asset value (NAV) of the fund. The NAV of the fund represents the value of the underlying asset of the ETF. The Sebi circular mandates disclosure of NAV (indicative) on a continuous basis throughout the day on the stock exchange. While the practice is already in existence, Sebi rules institutionalize it. Checking the NAV can help one avoid making a transaction at a significant premium or discount.

Can one execute ETF transactions directly?

Investors can buy or sell units of ETFs only on stock exchanges. But, large buy or sell transactions can also be directly placed with the fund house. Sebi now says orders greater than 25 crore alone can be placed for redemption or subscription directly with the asset management company (AMC). This is expected to direct the transactions up to this limit to the exchanges and enhance liquidity in ETF units. Nevertheless, there are few other exceptions specified where ETF transactions can be done directly with the AMC.

 

 

 

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