SEBI has recently suggested the launch of hybrid passive funds in India through a consultation document. Even though India already offers hybrid funds in different categories, the current rules require passive funds to track either an equity index or a debt index.
The new proposal seeks to permit AMCs to introduce passive hybrid products that mirror a composite index with set allocations of stocks and bonds, giving investors the opportunity to invest in one product with access to both types of assets. In this article, we will cover this concept in detail.
SEBI’s Proposal for Passive Hybrid Funds
SEBI has come up with proposals for three kinds of passive hybrid funds. They are:
- Debt-oriented passive hybrid fund: In such a fund, equity investment should be restricted to 25% of the portfolio, and the remaining 75% will go into fixed-income securities.
- Balanced passive hybrid fund: It will have 50% in equities and 50% in debt.
- Equity-oriented passive hybrid fund: There is a plan to commit 75% to equity and then use the rest on fixed income securities.
However, you might wonder which index will be used in generating each of these newly announced passive funds. The regulator stated that only broad-based indices from those containing equity shares of the top 250 companies ranked by market capitalization among all equity stocks shall be considered for the purpose of determining constituents of these funds, except as specified by the Association of Mutual Funds in India (AMFI) through its circulars from time to time.
This implies that stocks available include large-caps (the top 100 stocks) and mid-caps (the next 150 stocks). For instance, there may be options like Nifty50, Nifty100, Nifty200, Nifty Midcap150, Nifty LargeMidcap 250, etc., for equity exposure under passive hybrids.
With respect to the debt part of the portfolio, SEBI has recommended allowing only constant-duration debt indices. Furthermore, hybrid passive funds will not be permitted to include sectoral or thematic indices/funds (for equity) or target maturity funds (for debt). Just like in other categories, asset management firms can only introduce one scheme in each category. The scheme manager must maintain/rebalance the asset allocation quarterly.
Additionally, if the consultation paper gets the green light, fund houses can introduce hybrid index funds or exchange-traded funds (ETFs). This change is anticipated to provide increased flexibility and diversification options in the passive investment sector.
Usefulness of Passive Hybrid Funds
The Indian mutual fund industry is increasingly embracing passive funds, and retail investors now have an abundance of options when selecting the right passive fund for their portfolios.
A key advantage of choosing passive hybrid funds over active hybrid funds is the absence of fund manager risk. Since it can be challenging to select the best active hybrid fund each year, passive hybrid funds are a good alternative, especially if their allocation aligns with the investor’s goals.
Additionally, hybrid funds, particularly aggressive hybrid funds, are beneficial for maintaining tax-efficient asset allocation. These funds typically allocate between 65% and 75% to equities, with the remainder in debt, and they automatically rebalance portfolios periodically.
Final Words
If introduced as proposed, passive hybrid funds could provide investors with a new, diversified, and potentially more affordable way to invest in both equity and debt instruments. However, it is essential to thoroughly assess your investment objectives, risk tolerance, and the unique characteristics of the fund before deciding to invest in MF.
