SEBI's New Asset Class: With Sophisticated Strategies, Can it Outperform Traditional Mutual Funds?
The Securities and Exchange Board of India (SEBI) has recently proposed the introduction of a new asset class that bridges the gap between Mutual Funds (MFs) and Portfolio Management Services (PMS). This innovative category aims to cater to investors with a higher risk appetite and a minimum investment capacity of ?10 lakh, significantly lower than the ?50 lakh entry barrier for PMS.
One of the most exciting aspects of this development is the potential access it grants to sophisticated investment strategies like long-short funds and inverse ETFs.
With this new asset class, investors with a minimum of ?10 lakh can now explore these advanced strategies, previously limited to high-net-worth individuals and institutional investors.
To safeguard investors, SEBI proposes a 100% gross exposure limit. Gross exposure is the total value of a fund's investments, including both long and short positions. The 100% limit means that the gross exposure cannot exceed the total capital or assets under management (AUM) of the fund. This limit effectively prohibits highly leveraged products like multiple-times leveraged ETFs, which can amplify market movements and come with substantial risks.
To illustrate, let's consider a 3X leveraged index ETF. This ETF aims to deliver three times the daily return of its benchmark index. If the index moves up by 5%, the ETF would correspondingly increase by 15%. Conversely, if the index falls by 5%, the ETF would decrease by 15%. While such products are permitted in markets like the US and EU, they entail greater risk and may not yet be suitable for emerging markets like India.
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However, restricting exposure to 100% of the fund's AUM could have unintended consequences. For instance, a fund holding a 60% long position and a 40% short position in the form of put options would have substantial idle cash (approximately 35%) due to the low capital value of the options. Given SEBI's strict limits on bond holdings of these funds (10%), this cash would likely be parked in low-return assets like bank deposits. While this might boost liquidity for banks, it may not serve the best interests of investors seeking higher returns.
The introduction of these sophisticated instruments is expected to increase institutional participation in F&O markets, potentially enhancing liquidity and price discovery, though it may also introduce new volatility dynamics.
While these products offer exciting opportunities for risk-aware investors and could improve market depth, their structure needs careful consideration to ensure long-term effectiveness. The challenge lies in balancing innovation with prudent risk management, allowing these products to deliver superior risk-adjusted returns compared to traditional mutual funds in the long run.