Sebi Plans Second Fund Per Category to Address Mutual Fund Scalability Concern

In a major move aimed at striking a balance between investor interest and fund house flexibility, the Securities and Exchange Board of India (Sebi) has proposed allowing mutual fund houses to launch a second scheme within the same category—such as large-cap or mid-cap—under stringent conditions. The draft circular released on July 18 seeks public feedback till August 8, signaling Sebi’s intent to implement a framework that addresses fund scalability and operational complexities.

According to the draft, a fund house can launch a second mutual fund scheme in an existing category only if the first fund is at least five years old and has surpassed ₹50,000 crore in AUM (Assets Under Management). Additionally, the first fund must be closed to new subscriptions upon the launch of the second fund. Fund managers have lauded the proposal as a smart regulatory compromise, especially for large funds facing rebalancing and liquidity challenges.

• Fund managers call the proposal a practical fix for handling scale-related operational hurdles.

• Only eligible for categories like large-cap or mid-cap where growth pressure is high.

• Fund houses must close the existing fund to new investments before launching the second one.

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Cost Arbitrage Safeguarded with TER Cap

Sebi has also proposed that the Total Expense Ratio (TER) of the second scheme must not exceed that of the original fund, in order to prevent cost arbitrage and protect investors from higher charges. This would mean that if the first fund charges 1.25% TER, the second one cannot charge more.

• TER cap is seen as a “fair safeguard” by most fund managers.

• Industry suggestions include minor TER flexibility of 50–75 bps to accommodate distribution and marketing.

• TERs typically range between 0.1% to 2.25%, depending on the plan type (direct or regular).

SIP Continuity Emerges as a Grey Zone

One of the grey areas emerging from the draft is the treatment of existing Systematic Investment Plans (SIPs) in the original scheme once it is closed to new inflows. Fund houses are likely to request that SIPs be allowed to continue uninterrupted.

• Industry insiders believe SIP flows (1% of AUM monthly) are operationally manageable.

• Some fund houses recommend allowing SIP switches to the new fund automatically.

• Analogies suggest that staggered SIP investments will not burden fund execution mechanisms.

Clarity in Naming and Broader Regulatory Overhaul

To prevent investor confusion, Sebi has suggested that schemes be named as “Large Cap Fund – Series I” and “Series II”, introducing a logical naming convention for successive schemes. This, however, hasn’t entirely calmed distributor concerns about client confusion.

• Suggested naming aims to improve transparency but may need stronger communication strategies.

• Distributors are concerned about investor understanding and clarity during execution.

• Sebi’s draft also includes 20+ proposals, including refinements in debt fund labeling, rules for REITs/InvITs, and overlap guidelines for thematic/value/contra funds.

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