On 1st July 2024, SEBI released a consultation paper for “Introduction of Mutual Funds Lite Regulations (MF LITE) for passively managed Mutual Funds Schemes.” aimed to “reduce the compliance requirement, foster innovation, encourage competition and promote ease of entry for the MFs interested in launching only passive schemes”.
In this paper, SEBI has proposed the introduction of “Hybrid passive funds, which shall
replicate a composite index comprising fixed proportions of equity and debt and enable investors to invest in a single product having exposure to both equity and debt instruments”.
Three sets of hybrid passive schemes are allowed:
1 Debt-oriented => Equity: Debt – 25%:75% (taxed as per slab)
2 Balanced => Equity: Debt- 50%:50% (LTCG taxed at 20% with indexation)
3 Equity-oriented => Equity: Debt- 75%:25% (LTCG beyond Rs. 1 lakh across all such funds taxed at 10%)
Will the introduction of hybrid index funds be helpful to investors?
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It depends! Products and choices are only useful to those with a plan, and most investors excited about products don’t have a plan.
Equity-oriented hybrid index funds: We recommend avoiding ETFs. For details, Watch my talk on active vs passive investing in India.
Regular readers may be aware that nearly two years ago we pointed out that most actively managed aggressive hybrid funds do not beat an aggressive hybrid index – Why we badly need an aggressive hybrid index fund!
If a suitable (large cap) equity-oriented hybrid index fund is available, I would recommend it to most retail investors, especially first-time investors. I am a big fan of asset allocation. From a 100% equity portfolio, 25% (or even 35% is replaced with bonds; the risk is reduced a bit; the returns not as much. This is why diversification is called the only free lunch in investing. But it all depends on what the AMCs would dish out. So it is important not to get too excited about it.
Balanced hybrid passive funds: With 50% equity, it is a tricky category. It is too risky for those seeking lower volatility and drawdowns. It is not tax-friendly for those with a long investment duration (who would prefer the equity-oriented version). So, I would avoid this unless the person has a lot of money to play with.
Debt-oriented passive funds: Most investors will not like paying tax on capital gains as per slabs (unless their income levels are low). Then again, if they do not have much funds to play with, should they be investing in such a product?
Also, is it better to bet on an actively managed fund like Parag Parikh Conservative Hybrid Fund than a debt-oriented index fund (assuming it suits my needs)? I am inclined to say yes because the active fund would have more freedom to choose bonds across duration.
Let us wait for the products to be released before we get excited about it. We repeat that products and choices are only useful to those with a plan, and most investors excited about products don’t have a plan.