Table of Contents
Chapter 14: SEBI (Mutual Funds) Regulations, 1996
Mutual funds in India are established under the Indian Trusts Act, 1882 and regulated comprehensively by the SEBI (Mutual Funds) Regulations, 1996. The regulatory architecture enforces a structural separation between fund ownership, management, and asset safekeeping to eliminate systemic conflicts of interest.
Workflow & Structure Diagram
+---------------------------------------+
| SPONSOR (Promoter) |
| - 5-year financial track record |
| - Contributes >= 40% of AMC equity |
+---------------------------------------+
|
v
+---------------------------------------+
| BOARD OF TRUSTEES / TRUSTEE CO |
| - Holds fund assets in trust for BOs |
| - >= 66.6% Independent Trustees |
| - Fiduciary watchdog over AMC |
+---------------------------------------+
|
+---------------------------+---------------------------+
| |
v v
+-----------------------------------+ +-----------------------------------+
| ASSET MANAGEMENT COMPANY | | CUSTODIAN OF SECURITIES |
| (AMC) | | - Safekeeps portfolio securities |
| - Investment Manager (₹50 Cr NW) | | - Independent of AMC |
| - >= 50% Independent Directors | | - Settles market trades |
+-----------------------------------+ +-----------------------------------+
Key Constituents & Regulatory Qualifications
- The Sponsor: The corporate entity that initiates the mutual fund:
- Must have a continuous sound track record of carrying on business in financial services for at least five (5) years;
- Net worth must be positive in all five preceding years, and net worth in the immediately preceding year must exceed its capital contribution to the AMC;
- Must have earned profits after tax in at least three (3) out of the preceding five (5) years;
- Must contribute at least forty percent (40%) of the net worth of the Asset Management Company (AMC).
- The Trustees: The legal guardians of the fund property appointed under the Trust Deed:
- Must be persons of high integrity with clean regulatory records;
- Independence Mandate: At least two-thirds (66.6%) of the trustees must be independent (not associated with or related to the sponsor or its associates);
- A corporate trustee company must have at least two-thirds independent directors;
- Trustees conduct quarterly reviews of AMC transactions, ensure investments comply with scheme objectives, verify fair valuation, and report directly to SEBI half-yearly.
- Asset Management Company (AMC): The corporate investment manager appointed by the trustees:
- Must be approved by SEBI and maintain a minimum net worth of ₹50 Crores continuously;
- Board Independence: At least fifty percent (50%) of the directors of the AMC must be independent;
- The AMC cannot act as a trustee of any other mutual fund, nor can its directors engage in conflicting financial businesses without prior regulatory approval.
- The Custodian: An independent registered institution that safekeeps portfolio securities, manages gold/bullion deposits for Gold ETFs, collects dividends, and coordinates settlement with clearing corporations. The custodian must be completely independent of the AMC.
To prevent misleading naming conventions and eliminate overlapping products, SEBI's Scheme Categorization Framework standardizes mutual fund schemes into five distinct categories. An AMC can offer only one scheme per category (except Index Funds/ETFs, FoFs, and Sectoral/Thematic Funds).
1. Equity Schemes (11 Standard Categories)
- Multi Cap Fund: Minimum 75% in equity, with strict calibrated allocation: at least 25% in Large Cap, 25% in Mid Cap, and 25% in Small Cap stocks.
- Large Cap Fund: Minimum 80% in equity shares of large-cap companies (top 100 stocks by market capitalization).
- Large & Mid Cap Fund: Minimum 35% in large-cap stocks and minimum 35% in mid-cap stocks (101st to 250th by market capitalization).
- Mid Cap Fund: Minimum 65% in equity shares of mid-cap companies.
- Small Cap Fund: Minimum 65% in equity shares of small-cap companies (251st company onwards).
- Flexi Cap Fund: Minimum 65% in equity with dynamic, unconstrained allocation across large, mid, and small-cap stocks.
- Focused Fund: Minimum 65% in equity, subject to a strict ceiling of maximum thirty (30) stocks.
- ELSS (Equity Linked Savings Scheme): Minimum 80% in equity, carrying a statutory three (3) year lock-in with tax deductions under Section 80C.
- Sectoral / Thematic Fund: Minimum 80% in a specific economic sector (banking, pharma, auto) or theme (infrastructure, manufacturing).
- Dividend Yield Fund: Minimum 65% in dividend-yielding stocks.
- Value / Contra Fund: Minimum 65% in equity following a value or contrarian investment strategy (an AMC can offer either a Value Fund or a Contra Fund, not both).
2. Debt Schemes (16 Standard Categories by Tenor & Credit)
Categorized based on the Macaulay Duration of the portfolio and credit quality:
- Overnight Fund: Debt securities with maturity of 1 day.
- Liquid Fund: Debt and money market instruments with maturity up to 91 days.
- Ultra Short Duration Fund: Macaulay duration between 3 months and 6 months.
- Low Duration Fund: Macaulay duration between 6 months and 12 months.
- Money Market Fund: Money market instruments with maturity up to 1 year.
- Short Duration Fund: Macaulay duration between 1 year and 3 years.
- Medium Duration Fund: Macaulay duration between 3 years and 4 years.
- Medium to Long Duration Fund: Macaulay duration between 4 years and 7 years.
- Long Duration Fund: Macaulay duration greater than 7 years.
- Dynamic Bond Fund: Investment across debt durations dynamically managed by the fund manager.
- Corporate Bond Fund: Minimum 80% in corporate bonds rated AA+ and above.
- Credit Risk Fund: Minimum 65% in corporate bonds rated below AA+ (higher credit yield).
- Banking and PSU Fund: Minimum 80% in debt instruments of banks, Public Sector Undertakings (PSUs), and public financial institutions.
- Gilt Fund: Minimum 80% in Central and State Government Securities (G-Secs/SDLs).
- Gilt Fund with 10-Year Constant Duration: Minimum 80% in G-Secs maintaining a constant 10-year portfolio duration.
- Floater Fund: Minimum 65% in floating-rate debt instruments.
3. Hybrid Schemes (6 Standard Categories)
- Aggressive Hybrid Fund: 65% to 80% in equity; 20% to 35% in debt instruments.
- Conservative Hybrid Fund: 10% to 25% in equity; 75% to 90% in debt instruments.
- Dynamic Asset Allocation / Balanced Advantage Fund: Dynamic management between 0% and 100% equity/debt based on quantitative valuation models.
- Multi Asset Allocation Fund: Minimum 10% invested in at least three (3) distinct asset classes (typically Equity, Debt, and Gold/Commodities).
- Arbitrage Fund: Minimum 65% in equity arbitrage strategies (simultaneous cash and futures positions).
- Equity Savings Fund: Minimum 65% in equity (directional + arbitrage) and minimum 10% in debt.
Net Asset Value (NAV) represents the fair market book value of one mutual fund unit. The regulations prescribe exact valuation rules, cut-off timings, and cash realization mandates.
Mathematical Formulation of NAV
$$NAV = \frac{(\text{Market Value of Investments} + \text{Receivables} + \text{Accrued Income}) - (\text{Liabilities} + \text{Accrued Expenses})}{\text{Total Number of Outstanding Units}}$$
NAV must be computed daily and published on the websites of the AMC and the Association of Mutual Funds in India (AMFI) by 11:00 PM on every business day (or 9:00 AM the next day for Fund of Funds).
Standard Cut-off Timings & The Uniform Realization Rule
Workflow & Structure Diagram
+-----------------------------------------------------------------------------------+
| OFFICIAL CUT-OFF TIMINGS & NAV ALLOTMENT |
+-----------------------------------------------------------------------------------+
| 1. LIQUID & OVERNIGHT SCHEMES: |
| - Official Application Cut-off: 1:30 PM |
| - Funds credited to AMC bank account before 1:30 PM -> Prior Day NAV |
| |
| 2. ALL OTHER SCHEMES (Equity, Debt, Hybrid): |
| - Official Application Cut-off: 3:00 PM |
| - Universal Realization Rule: Regardless of application size (even ₹500 SIPs), |
| the closing NAV of the day is allotted STRICTLY if funds are REALIZED into |
| the scheme bank account before 3:00 PM on that business day |
+-----------------------------------------------------------------------------------+
Total Expense Ratio (TER) Limits (Regulation 52)
The maximum TER an AMC can charge to a scheme is calibrated on a progressive sliding scale based on the Daily Net Assets of the scheme:
- For Equity Schemes: Maximum 2.25% on the first ₹500 Crores of daily net assets, reducing progressively to 1.05% for assets above ₹50,000 Crores.
- For Debt Schemes: Maximum 2.00% on the first ₹500 Crores, reducing progressively.
- Additional TER: Up to 30 bps (0.30%) permitted for inflows from B-30 (Beyond Top 30) cities to incentivize retail financial inclusion, and up to 5 bps in lieu of exit load.
Mutual fund governance integrates specialized risk mitigation frameworks to protect retail investors from debt credit defaults and liquidity shocks.
Side-Pocketing (Creation of Segregated Portfolio)
When a debt instrument in a mutual fund portfolio suffers a sudden credit default or is downgraded below investment grade (BBB-):
- Separation: The AMC may carve out the stressed debt asset into a separate, isolated "Segregated Portfolio" (side-pocket).
- Proportionate Unit Issuance: Existing unitholders receive equal units in the segregated portfolio matching their units in the main portfolio.
- Liquidity Ring-Fencing: New investors entering the main portfolio do not bear past credit losses, while existing unitholders retain recovery upside when recovery proceeds from the defaulted instrument are realized.
- Trustee Approval: Creation of a segregated portfolio requires formal approval from the Board of Trustees within twenty-four (24) hours of the credit event.
The Six-Tier Risk-o-meter
Every scheme must display a dynamic Risk-o-meter calibrated across six levels:
- Low $\rightarrow$ Low to Moderate $\rightarrow$ Moderate $\rightarrow$ Moderately High $\rightarrow$ High $\rightarrow$ Very High.
- The risk score is re-evaluated monthly based on portfolio duration, credit rating scores, and equity volatility.
Stewardship Code for Mutual Funds
As institutional fiduciaries, AMCs must implement a Board-approved Stewardship Code:
- Monitor investee companies on corporate strategy, risk, corporate governance, and ESG factors;
- Actively vote on all shareholder resolutions (promoter compensation, related-party transactions, mergers);
- Disclose quarterly voting records and reasoned rationales on the AMC website.