The Securities and Exchange Board of India (SEBI) has allowed mutual fund houses to launch passive Equity-linked Saving Scheme (ELSS) with effect from July 01, 2022. Mutual Fund houses can launch passive ELSS (through Index Fund) under ‘other schemes’ category. Notably, passive schemes in other equity funds categories such as large-cap, mid-cap, multi-cap, etc. are already in existence.

ELSS, also known as tax saving mutual funds, are diversified equity funds that offer the dual advantage of wealth-building potential and tax-saving benefits. Unlike other open-ended equity schemes, ELSS comes with a lock-in period of 3 years which is among the lowest compared to other tax-saving instruments. This means that you can redeem your investment only after the lock-in period ends. In case of investment via the Systematic Investment Plan (SIP), each contribution is subject to a lock-in of 3 years.

According to SEBI’s circular, passive ELSS will be based on one of the indices comprising equity shares from top 250 companies in terms of market capitalisation. This means that passive ELSS can invest predominantly in large-cap and mid-cap companies, tracking indices such as Nifty 50, Nifty 100, Nifty 200, Nifty Large Midcap 250, etc. Currently, most active ELSS invest across market cap but with a large-cap bias.

The launch of passive ELSS is a welcome move for investors as they will benefit from the growth potential of equities at a low cost. They will also be able to avail of tax benefits that are associated with ELSS investment. As you may be aware, investments in ELSS of up to Rs 1.5 lakh in a financial year are eligible for deduction under Section 80C of the Income Tax Act, 1961.

However, SEBI has stated that mutual fund houses can either launch active ELSS or passive ELSS, and not both. Most mutual fund houses (36 out of around 40) currently have active ELSS in their offering. These schemes collectively manage AUM of around Rs 1.4 lakh crore.

Thus, passive ELSS are unlikely to come into existence in a big way any time soon. Only recently mutual fund houses that are looking to expand their product range may find this beneficial. In order to promote it, SEBI will have to alter its guidelines to allow mutual fund houses to launch both active and passive ELSS.

SEBI has also prescribed several other norms, including operating norms for Debt Index Funds and ETFs.

Here are few other passive fund norms as per SEBI’s circular:

Tracking error and tracking difference

The tracking error i.e. the annualized standard deviation of the difference in daily returns between the underlying index and the NAV of the ETF/ Index Fund (other than Debt ETFs/Index Funds) based on past one year rolling data should not exceed 2%. In case of unavoidable circumstances in the nature of force majeure, which are beyond the control of the AMCs, the tracking error may exceed 2% and the same should be brought to the notice of Trustees with corrective actions taken by the AMC, if any.

For ETFs/Index Funds in existence for a period of less than one year, the annualized standard deviation will be calculated based on available data.

All ETFs/Index Funds (including Debt ETFs/ Index Funds), have to disclose the tracking error based on past one year rolling data, on a daily basis, on the website of respective AMCs and AMFI.

Along with tracking error, tracking difference i.e. the annualised difference of daily returns between the index and the NAV of the ETF/Index Fund will also be disclosed on the website of the AMC and AMFI, on a monthly basis, for tenures 1 year, 3 year, 5 year, 10 year and since the date of allotment of units.

For Debt ETFs/Index Funds the annualized tracking difference averaged over one year period should not exceed 1.25%. In case the average annualized tracking difference over one year period for Debt ETFs/ Index Funds is higher than 1.25%, the same should be brought to the notice of trustees with corrective actions taken by the AMC, if any.

Disclosure of indicative net asset value (iNAV)

iNAV of an ETF i.e. the per unit NAV based on the current market value of its portfolio during the trading hours of the ETF, will be disclosed on a continuous basis on the Stock Exchange(s), where the units of these ETFs are listed and traded and will be updated in the following manner:

i. For Equity ETFs, within a maximum time lag of 15 seconds from underlying market.

ii. For Debt ETFs, at least four times a day i.e. opening and closing iNAV and at least two times during the intervening period with minimum time lag of 90 minutes between the two disclosures.

iii. For ETFs on Gold or Silver, based on the latest available data for Gold or Silver. Accordingly, iNAV disclosed for Gold or Silver ETFs may either be static or dynamic depending upon the availability of the underlying price.

iv. For ETFs on international indices, based on the latest available data regarding the portfolio of the ETF. Accordingly, iNAV disclosed for international ETFs may either be static or dynamic depending on the intersection in trading hours of domestic and overseas markets.

v. For disclosure of iNAV, AMCs and Stock Exchanges will develop suitable mechanism for data sharing.

Rebalancing period for Equity ETFs/Index Funds

In case of change in constituents of the index due to periodic review, the portfolio of equity ETF/Index Funds should be rebalanced within 7 calendar days.

Any transactions undertaken in the scheme portfolio of ETF/ Index Fund in order to meet the redemption and subscription obligations should be done while ensuring that post such transactions replication of the portfolio with the index is maintained at all points of time.

To conclude:

SEBI has issued comprehensive guideline for operating of passive funds. This could potentially give a boost to the launch of more passive funds and will prove to be especially beneficial for investors looking for a low-cost alternative to earn returns in line with the market.

This article first appeared on PersonalFN here

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