Sebi Clarifies Portfolio Rebalancing Timeline For Passive Breaches In Mutual Fund Schemes – Know Impact On Investors

Sebi Circulars on Mutual Funds: The capital market regulator, Sebi, issued a clarification via a circular on June 26 stating that the prescribed timeline for portfolio rebalancing in mutual fund schemes will be applicable to all kinds of passive breaches in actively managed mutual fund schemes. The market regulator issued the clarification following a recommendation by the Mutual Funds Advisory Committee (MFAC). Before Sebi issued the circular, the 30-business-day timeline was applicable only to passive breaches related to asset allocation.

“In view of...the recommendation of the Mutual Funds Advisory Committee (MFAC), it is clarified that the provisions shall be applicable for all types of passive breaches for the actively managed mutual fund schemes,” the market regulator said in a circular.

What Are Active and Passive Breaches?

The market regulator has put several prudential limits, such as issuer limits, group limits, sector limits, etc., to regulate the way mutual fund schemes allocate funds to various assets. Sometimes, asset management companies breach these limits. Notably, deliberately breaching these limits through omission and commission by AMCs is termed as an ‘active breach’. On the other hand, a ‘passive breach’ refers to the fund house breaching the limit by making unintentional deviations from the mandated asset allocation of the scheme or the prudential limits put in place by Sebi. Some common causes for such breaches are corporate actions by companies, drastic price movements in the securities in which the fund invests or the maturity of instruments in which the fund invests.

In case of any instance where a fund house breaches the limits mentioned above, Sebi has mandated a rebalancing period of 30 business days for all schemes. Notably, index funds and exchange-traded funds (ETFs) are exempt from this rebalancing timeline. In this context, portfolio rebalancing refers to the periodic systematic adjustment of the asset allocation of a scheme’s assets to keep it in line with the goals of the scheme and the prudential limits prescribed by the Sebi.

If the rebalancing is not done within the prescribed timeline, the AMCs have to submit written justification for the same to the Investment Committee. The Investment Committee can then extend the timeline for rebalancing to up to 60 business days. However, if the AMC still doesn’t undertake the rebalancing, they are disallowed from launching new schemes till the rebalancing is complete, and they cannot levy an exit load on exiting investors of such schemes, according to Sebi’s latest Master Circular for Mutual Funds.

“In case the portfolio of schemes (all schemes other than index funds and exchange-traded funds) mentioned in the paragraph above are not rebalanced within the above-mandated timelines, justification in writing, including details of efforts taken to rebalance the portfolio, shall be placed before the investment committee. The Investment Committee, if so desired, can extend the timelines up to sixty (60) business days from the date of completion of the mandated rebalancing period,” Sebi said in the Master Circular.

What’s In It For Investors

The regulator mentioned in the circular that while breaches are considered violations of Sebi mutual fund norms, passive breaches can sometimes happen due to external factors and market dynamics. The market regulator highlighted that such breaches can still impact the risk profile of the scheme. Thus, portfolio rebalancing becomes extremely important to protect the interests of investors in securities and to regulate the securities market.

Notably, by making sure that portfolio rebalancing after breaches is done on time, AMCs can ensure that better risk management is practised and the return potential is in line with the scheme document.