India rolls out ‘flexi cap’ mutual funds following industry pressure to ease new rule

November 6, 2020.
The headquarters of Franklin Templeton in San Mateo, Calif. (Coolcaesar/Creative Commons)

The headquarters of Franklin Templeton in San Mateo, Calif. (Coolcaesar/Creative Commons)

Some mutual funds in India will be allowed to invest more freely in stocks of all sizes through the introduction of a new fund category by the country's securities regulator, which comes after a lobbying efforts by the investment industry to ease restrictions.

The issued new guidance on Friday that allows for the change. Indian fund managers may convert existing funds to the so-called “flexi cap” scheme, which requires that funds in the new category allocate at least 65% of their assets to equities, while allowing them to invest without restrictions on market capitalization.

The move follows an earlier SEBI decision in September that required multi-cap funds to allocate funds equally to large-, mid- and small-cap stocks. This and other reforms arrived amid fresh concerns over liquidity and valuation at fund houses like Franklin Templeton India, which sought to abruptly unwind six debt schemes earlier this year.

While the latest rule was generally received well by the industry, others are skeptical of the growing number of fund categories in the country as part of SEBI’s prescriptive regulatory approach.

"The earlier multi-cap category had the same flexibility. Now that has been made similar to the large- and mid-cap category and this new category has been created,” said Vidya Bala, co-founder of mutual fund research firm Prime Investor, in an interview with Indian financial publication Mint. 

“I don’t think this constant creation of new categories is helpful,” she added. “It becomes an asset-gathering exercise for fund houses.”

SEBI simultaneously moved to tighten debt schemes in the country with a new rule on Friday requiring most open-ended schemes to hold at least 10% of their net assets in liquid assets.

On Thursday, the regulator doubled the limit on overseas investments to $600 million per mutual fund and $7 billion for the overall industry, including up to $200 million in international exchange-traded funds per mutual fund.

These changes reflect a balancing act for SEBI after criticism from analysts and fund managers who said the earlier restriction would lead to a significant outflow of funds from large-cap stocks to mid- and small-cap stocks to comply with the 25% ceiling.

Following the September decision, the Association of Mutual Funds in India reportedly expressed its concerns to regulators and proposed that a new fund category be created to accommodate funds that are more heavily invested in large-cap companies.

During AMFI’s 25th annual general meeting in September, SEBI Chairman Ajay Tyagi clarified that the allocation limit was implemented so that multi-cap funds operate true to their name, and that the regulator was considering the trade group’s proposal.

“It is not the intention of the regulator to force the industry to invest in anything,” Tyagi said, according to local reports. “In this regard, AMFI has made its representation which is being examined actively, and the announcement would be made soon.” 

SEBI has enacted a number of stringent new rules for mutual funds and debt schemes this year, including a new code of conduct for chief investment officers of asset managers and additional liquidity requirements for schemes that wish to transfer its assets to another scheme within the same fund.

These reforms come as the Indian government investigates Franklin Templeton, which has become a poster child for allegations of fraud and excessive risk-taking in the sector.

The San Mateo, California-based investment firm was forced to suspend shareholder votes on the liquidation of six debt mutual funds after the High Court of Gujarat ordered it to stay put until a forensic audit of the funds is made public. 

The funds, which reportedly held INR 476 billion ($6.44 billion) in assets in the summer of 2018, had lost roughly 35% of their value by the time COVID-19 broke out in March as a liquidity crisis rocked India’s financial markets, Business Today reported. The firm subsequently began to liquidate the funds in April 2020.

In late August, a shareholder lawsuit seeking information revealed that SEBI said it had not given permission to Franklin Templeton to begin unwinding its debt schemes before allegations against the company were investigated.

Representatives for Franklin Templeton have vehemently denied the allegations in earlier statements and maintained that the company acted according to local laws.

“As stated in all our previous communications, the decision to wind up these schemes was taken in accordance with regulation 39(2)(a) and was taken in order to protect value for investors and presented the only viable means to secure an orderly realization of portfolio assets,” the company told Fastinform in August.