New proposed asset class by SEBI

Last month, the Securities and Exchange Board of India (SEBI) sought public comments on a new product it plans to introduce in the Indian capital markets, tentatively called the “New Asset Class.” This offering aims to bridge the gap between Mutual Funds and Portfolio Management Services (PMS) in terms of flexibility in portfolio construction. It also seeks to provide investors with a regulated investment product featuring higher risk-taking capabilities and a higher ticket size, while curbing the proliferation of unregistered and unauthorized investment products, according to SEBI's consultation note published last month.

Why a New Product?

In the consultation paper, SEBI explained the rationale behind introducing this new asset class. SEBI believes that the investment landscape in India has changed dramatically over the past few years, necessitating a product that meets the evolving needs of a new set of investors.

Currently, available products include Mutual Fund schemes, which are retail-oriented with investment sizes starting as low as Rs. 500, Portfolio Management Services (PMS) with a ticket size of Rs. 50 lakhs, and Alternative Investment Funds (AIF) with a minimum investment value of Rs. 1 crore.

SEBI noted, “Over the years, a notable opportunity for a New Asset Class has emerged between Mutual Funds and PMS in terms of flexibility in portfolio construction. The absence of such an investment product appears to have inadvertently propelled investors in this segment towards unregistered and unauthorized investment schemes/entities. Such schemes often promise unrealistically high returns and exploit investors’ expectations for better yields, leading to potential financial risks. Therefore, a New Asset Class would provide a regulated and structured investment suited to investors in this segment. Considering that the New Asset Class is intended to have a risk-return profile between MFs and PMS, the proposed regulatory framework needs to enable higher risk-taking than Mutual Funds while incorporating appropriate safeguards and risk mitigation measures.”

Indeed, SEBI has identified several illegal "PMS" providers over the past few years that promise quick and easy returns. Participants in these schemes were often encouraged to recruit new investors, profiting from their investments, much like a pyramid scheme. Some "PMS schemes" even offered luxury cars as incentives, though they were not listed as PMS providers on SEBI’s website.

How Will the New Product Be Different?

This new asset class will cater to investors who cannot invest Rs. 50 lakh in a PMS but can allocate Rs. 10 lakh for investments. It will allow them to utilize differentiated investment strategies such as long-short equity and inverse exchange-traded funds.

The proposed asset class will offer greater investment flexibility compared to traditional Mutual Funds. This includes higher limits for single issuers in debt (20% of assets, up from 10%) and equity securities, as well as increased exposure to credit risk and voting rights (15%, up from 10%). Additionally, the new class allows for greater investment in the equity of any company (15%, up from 10%) and larger investments in REITs, INVITs, and specific sectors. Unlike Mutual Funds, which are often limited in how much they can invest in various segments of the market or in a single company, this new asset class will have fewer restrictions.

To differentiate this new asset class from traditional Mutual Funds, PMS, AIFs, REITs, and INVITs, SEBI plans to give it a unique name once the consultation process is completed. Not everyone will be allowed to offer this new product. Asset management companies interested in offering it will need to demonstrate a proven track record, including at least three years of operation and an average AUM of Rs. 10,000 crore over the preceding three years.

Disclosures

Mutual Funds often hold a wide variety of stocks—ranging from 40 to 50—and frequently churn their portfolios, with SEBI mandating strict and regular public disclosures of all changes. PMS portfolios are more condensed, typically holding around 20 to 30 stocks, with disclosures often provided directly to clients rather than the public.

In this new product, SEBI has proposed stringent regulatory standards, including monthly portfolio disclosures and publicly accessible foundational documents, similar to Mutual Funds.

This asset class is likely to attract upper-middle-class investors who have surplus funds to invest but not as much as Rs. 50 lakh. However, it is expected to come with higher costs, as PMS typically charges more than Mutual Funds, and this new offering is positioned between an MF and a PMS.

Taxation

The government has recently made several changes to Mutual Fund taxation, and the taxation of this new product remains unclear. Currently, long-term capital gains (LTCG) on Mutual Funds are taxed at 12.5%, while short-term capital gains from stocks, equity funds, and units of business trusts (InvITs and REITs) are taxed at 20%. PMS attracts higher taxation because while MFs do not pay taxes when selling stocks, PMS schemes do when they churn their holdings.

Conclusion

While the new asset class will likely garner significant attention in the booming Indian stock market, which has remained resilient despite various challenges over the past few years, it remains to be seen whether this product will significantly outperform Mutual Funds. It’s important to note that this product will carry higher risks than a typical Mutual Fund scheme. Many personal finance experts also believe this offering might detract from the benefits of simple, focused investing over the long term and instead attract those seeking a new and exciting investment approach.