The Securities and Exchange Board of India (SEBI) has issued a circular to define timelines for rebalancing of portfolio of mutual fund schemes.

Mutual funds now have to mandatorily rebalance schemes within 30 days in the event of deviation from the mandated asset allocation mentioned in the Scheme Information Document (SID) due to passive breaches. Passive breaches are those that have not arisen out of omission and commission of Asset Management Companies (AMCs). This new SEBI guideline will apply to all schemes, excluding Overnight Funds, Index Funds, and Exchange Traded Funds (ETFs), and will come into effect from July 01, 2022.

SEBI has further stated that if the portfolio of the scheme is not rebalanced within 30 days, then a justification in writing, including details of efforts taken to rebalance the portfolio, will have to be placed before the Investment Committee of the AMC. The Investment Committee can extend the timelines up to 60 business days from the date of completion of the mandated rebalancing period if necessary.

However, if the portfolio of the schemes is not rebalanced within the extended timelines, SEBI can prohibit the AMC from launching any new scheme till the time the portfolio is rebalanced. Furthermore, AMCs will not be allowed to levy exit load, if any, on the investors exiting such scheme/s.

In addition, SEBI has proposed the following reporting and disclosure requirements:

I) AMCs will report the deviation to Trustees at each stage.

II) In case the AUM of the deviated portfolio is more than 10% of the AUM of the main portfolio of the scheme, the AMCs will have to take the following actions-

• Immediately disclose the same to the investors through SMS and email/letter, including details of the portfolio not rebalanced
• Immediately communicate to investors through SMS and email/letter when the portfolio is rebalanced
• The subject line of the aforementioned emails/letters should be uniform across the mutual fund industry and clearly indicate ‘breach of’ / ‘deviation from’ mandated asset allocation

III) AMCs have to disclose any deviation from the mandated asset allocation to investors along with periodic portfolio disclosures as specified by SEBI from the date of lapse of mandated plus extended rebalancing timelines.

How will SEBI’s guideline impact mutual fund investors?

SEBI has issued the circular in order to bring uniformity across Mutual Funds with respect to timelines for the rebalancing of scheme’s portfolio.

For mutual fund investors, this is a positive move as they will not have to worry about whether the scheme is following the asset allocation as mentioned in the SID. It will also allow investors to stay on the right track to achieve their financial goals with a mutual fund portfolio that aligns with their risk profile.

For example, Conservative Hybrid Funds have a mandate to invest 75% to 90% of their total assets in debt instruments and the balance 10% to 25% in equities. The equity allocation can breach the maximum limit of 25% in the event of a sharp bull market rally, thus making the portfolio unsuitable for conservative investors. SEBI’s guidelines on mutual fund portfolio rebalancing will ensure that the fund managers stick to the asset allocation mentioned in the SID.

Notably, most fund managers diligently ensure that the allocation aligns with the set investment objective. However, the timely for rebalancing the portfolio in case of deviation from the stated allocation varies from one mutual fund house to another. This can expose the portfolio to undue risk and can also create challenges in comparison of schemes within the same category.

Thus, SEBI’s move will bring discipline among AMCs to rebalance the portfolios within the fixed timeline and stay true-to-label.

What should investors do?

It is important that you select mutual funds carefully based on a host of parameters (both quantitative and qualitative) not limited to the returns generated by the scheme/s. The fund should be able to adequately reward investors with suitable returns without taking excessive risk.

Furthermore, you should be looking at the portfolio characteristics of the scheme to assess its ability to generate reliable returns by analysing the following:

• Whether the scheme is well-diversified across stocks and sectors

• The quality of securities held

• Portfolio churning rate

• The qualification and experience of the fund manager

• The efficiency of the fund house in following the best investment and risk management practices

If you want to narrow down on the best mutual funds, these factors are of utmost importance.

This article first appeared on PersonalFN here