The Securities and Exchange Board of India (Sebi) has come out with a circular regarding the timeliness of mutual fund portfolio rebalancing. This new rule will come into effect from July 1, 2022.
So what does this new circular say? And what does a mutual fund portfolio rebalancing mean? Let us find out more.
What Is Mutual Fund Portfolio Rebalancing?
Every mutual fund has to furnish a Scheme Information Document (SID), wherein all the essential details are listed out about that respective fund. This document will have comprehensive information about the fund’s objective, investment style, fund manager’s details, stocks to be purchased, criteria to be followed, percentage of holding, among others. All the necessary details regarding the scheme are mentioned in the SID.
“Sebi has strictly defined the categorisation of mutual funds like large-cap, mid-cap, multi-cap, and so on. This definition lays out the rules regarding what a particular fund can own according to its category. But what happens is that deviations occur because of market movements. For example, let’s suppose you are running a large-cap and a mid-cap fund, wherein you have to invest at least 35 per cent in large- and mid-cap stocks, respectively. So now, due to the better performance of mid-cap stocks, the fund’s overall position in mid-cap stocks have risen above the mandated 35 per cent and hence caused a deviation from the SID,” says Sorbh Gupta, fund manager – equity, Quantum Mutual Fund
As equity markets are highly volatile, the prices move very rapidly. So, a mutual fund scheme might deviate from its objective in the course of its term. Now, the fund manager will have to check if its large- and mid-cap holdings are balanced according to the mandated rule and SID. This is called mutual fund portfolio rebalancing. The fund has to be aligned with its SID and mandated to the rule regarding the same, or, it has to provide a justification as to why it is not aligned with the SID.
“Sebi wants to make sure that as far as mutual fund investors are concerned it’s “what you see is what you get”. I think it’s a good move which will make sure fund managers stick to the mandate and investors planning their asset allocation can, at least, bank on consistency with scheme objectives, if nothing else,” says Atanuu Agarrwal, co-founder of Upside AI, an ML-backed Portfolio Management Service company.
What Does The Sebi Circular Say Regarding The Same?
The Sebi circular has said that if the said mutual fund scheme has deviated from its SID due to circumstances beyond its control, i.e., due to no action of its own, then it will have to rebalance its portfolio according to its SID.
“Setting timelines to rebalance mutual fund portfolios according to the scheme’s SID will bring discipline among all AMCs, and will also benefit the investors in a way that it will help them to stay on the right path to achieve their financial goals. This directive to fix the disparity between the investment strategy and actual asset allocation within a fixed timeframe will help the investors to stay true to their risk appetite,” says Shaily Shah, co-founder, tarrakki, a comprehensive digital wealth management platform.
“In the event of deviation from mandated asset allocation mentioned in the SID due to passive breaches (occurrence of instances not arising out of omission and commission of AMCs), rebalancing period across schemes shall be as follows:
1] Overnight Fund: Not Applicable
2] All schemes other than Index Funds and Exchange Traded Funds: 30 business days
How Will Fund Houses Report This?
Sebi has directed every asset management company (AMC) to report the deviation in its schemes (if any) at each stage to the respective trustees. However, if the asset under management (AUM) of the deviated portion of the fund’s portfolio is more than 10 per cent of the total AUM of the portfolio, then the AMCs will have to inform the investors of the scheme immediately.
The AMCs will have to convey this via SMS, email/letter, and include the portfolio details, which are yet to be rebalanced. Then after the portfolio is rebalanced, AMCs will again inform investors via SMS—email/letter. The subject line of the email/letter will be the same across all AMCs, and should clearly indicate “breach of/deviation” from mandated asset allocation.
What Will Happen If The Fund Is Not Rebalanced According To SID?
Sebi has said in the circular that if the rebalancing of funds is not done within the 30-day timeframe, then a clear justification in writing has to be submitted to the Investment Committee of the AMC. This justification will also include all the details of efforts that the respective fund has undertaken to rebalance its portfolio.
“So, Sebi has said in this circular that within 30 days, you have to rebalance your fund’s portfolio if it is deviated, and make it aligned with the mandated rules. But you can submit a written explanation to the AMC’s Investment Committee and explain to them why you have failed to rebalance your deviated portfolio. They can then grant you with an extension up to 60 more business days,” adds Gupta.
After reading this written justification, the Investment Committee could extend the timeline to rebalance the portfolio up to 60 business days from the date of completion of the mandated rebalancing period.
If the fund is still not rebalanced after this, then the AMC will not be permitted to issue any new scheme until the rebalancing of the portfolio work is done; and it shall not levy any exit load from investors exiting such non-rebalanced fund.
