There is a wide variety of investment options in today's market, that on one hand give the investors an extensive range to choose from, but on the other hand, can prove to be confounding and challenging, especially for retail investors. Mutual Funds, as popular as they are, have grown extremely diverse and tricky.

SEBI is the main market regulator and its duty is to make sure that investors investing in Mutual Funds are being safeguarded by implementing rules & regulations from time to time. SEBI's primary aim is to simplify mutual fund schemes by providing investors proper understanding and flexibility.

For instance, on October 6, 2017, SEBI had mandated for Mutual Fund Houses to categorise all their current and future schemes into 5 broad categories being Equity, Debt Mutual Funds, Hybrid Mutual Funds, Solution Oriented and others. These were to be further segregated into 36 sub-categories.1

In the wake of this pandemic, the country's economy is in a state where investors want to benefit from the possibility of higher returns but hidden loopholes and unspirited working of some Fund Houses and Asset Management Companies (AMCs), makes it tough for retail investors to derive that advantage. Therefore, SEBI has issued three circulars, bringing the long-overdue reform to life. By stiffening the rules, SEBI advocates transparency by making information handy and easier to understand for investors, albeit increasing compliance costs and complexity for Fund houses.

I. Renaming Dividend Options

SEBI vide its circular has mandated that all the existing and proposed Schemes of Mutual Funds shall rename the Dividend option(s) in the following manner:

  • Dividend Payout to be renamed as Payout of Income Distribution cum capital withdrawal option.
  • Dividend Re-investment to be renamed as Reinvestment of Income Distribution cum capital withdrawal option.
  • Dividend Transfer Plan to be renamed as Transfer of Income Distribution cum capital withdrawal plan.

The circular also states that offer documents shall clearly disclose that the amounts to be distributed include a chunk out of investors capital (Equalization Reserve), which is part of the sale price that represents realized gains, and that such disclosures shall be made to investors at the time of subscription itself.2

In addition to this, the AMCs shall ensure that whenever a distributable surplus is given out, clear segregation between income distribution (appreciation on NAV) and capital distribution (Equalization Reserve) is suitably disclosed in the Consolidated Account Statement provided to investors. The changes shall be effective from April 1, 2021.3

By investing in mutual funds, investors have the options of growth, dividend and dividend reinvestment. These options are a way for investors to derive profits from their money and receive an income. However, many investors are unaware that the declared dividends contain a part of their capital as well.

The logic behind renaming these dividend options with such detailed titles is an attempt to make them self-explanatory. This way the investors, by being more informed, can opt for a systematic withdrawal plan to realize regular income if needed, all the while keeping a watch and maintaining a lower withdrawal rate than the growth rate of the fund to keep them from accidentally cutting into their capital.

II. Revamping the Risk-o-Meter

SEBI has a system of product labelling in place to ensure that the investors select the mutual fund scheme that is best suited to their individual risk profile. This concept is illustrated by a Risk-o-meter, indicating the level of risk in any specific mutual fund scheme.

Thus far, the meter used to indicate five risk areas - Low, Moderately Low, Moderate, Moderately High and High Risk. Based on the recommendation of the Mutual Fund Advisory Committee (MFAC), SEBI has now introduced, 'Very High Risk' as the sixth risk profile for the Mutual Fund schemes. However, it is not just a simple addition of another category, the real overhaul is the change in the methodology behind calculating these risks and the extensive procedure for their disclosure.

So far, the level of risk was being denoted as per categories, however, going forward, it will have to be denoted as per schemes. Based on specific characteristics of each scheme, Mutual Funds shall assign a risk level to these schemes at the time of launch itself. Any change will have to be properly communicated to the investors by way of Notice cum Addendum and by way of an e-mail or SMS to unitholders of that particular scheme. Risk-o-meter shall be evaluated on a monthly basis as well as annually along with number of times the risk level has changed over the year and Mutual Funds/AMCs are mandated to disclose these results on their respective websites and on AMFI website.4

The circular also dictates that the product label shall be:

  • Disclosed on the front page of the initial offering application form, Scheme Information Documents (SID) and Key Information Memorandum (KIM).
  • Disclosed on the common application form – along with the information about the scheme.
  • Placed in proximity to the caption of the scheme and should be prominently visible.
  • Disclosed on scheme advertisements

This new mandate shall come in force with effect from January 1, 2021, to all the existing and future schemes thereafter. However, mutual funds may choose to adopt the provisions before the effective date.5

This regulation brings about true dynamism and transparency in the risk rating and portfolio disclosure. While equity funds may be easier to evaluate, pricing out the debt funds can be precarious. where the bond quality can change drastically over time, keeping the investor in oblivion. Going forward, the evaluation will differ for both types of funds as per their nature. The debt funds will be evaluated based on the interest rate, credit and liquidity, whereas the equity funds will be evaluated on market cap, volatility and impact cost. This will ensure that higher returns are not used as bait without indicating the higher risk that follows.

III. Regulating Inter-Scheme Transfers

SEBI has tightened the norms for inter scheme transfer for mutual funds. This circular reads that in case of close-ended schemes, the inter scheme transfer purchases would be allowed only within 'three' business days of allotment pursuant to new fund offer (NFO).6

Whereas, in case of open-ended schemes, the inter scheme transfer purchases would be permitted either for meeting liquidity requirements in a scheme in case of unanticipated redemption pressure or to facilitate duration, issuer, sector or group rebalancing. This regulation shall be applicable with effect from January 1, 2021.7

Currently, transfer of securities from one scheme to another in the same mutual fund is allowed only if such transfers are done at the prevailing market price for quoted instruments on a spot basis and the securities so transferred are in conformity with the investment objective of the scheme to which such transfer has been made.8

Fund Houses or AMCs have options at their disposal for liquidity management and are free to use their discretion in the best interest of the investors. However, they loosely opt to misuse inter-scheme transfers by placing non-performing stocks, risky bonds and other downgraded securities in schemes that are largely open for retail investors rather than institutional investors.

The new mandate not only lays firm conditions but also holds strict accountability for resorting to inter scheme transfer for managing liquidity. Therefore, inter scheme transfer can only be sought when other avenues such as cash and cash equivalent, market borrowings and selling of scheme in the market, among others are attempted and exhausted.

To further discourage the misuse of inter scheme transfer, SEBI states that trustees of the AMCs shall ensure a solid mechanism is in place to negatively impact the performance incentives of fund managers, chief investment officers (CIOs), etc. involved in the process in case the security becomes default grade within a period of one year of such transfer. If the security gets downgraded following inter scheme transfer within a period of four months, the Burden of Proof befalls the fund manager involved, to provide detailed justification to the trustees for buying such securities.9

Concluding Remarks

Although, this may be construed as micro-management on part of the regulator, however, the recent trends have indicated a dire need for such interference by the authorities. This is especially to safeguard the interests of the retail investors who become easy prey to fund managers trying to inflate their numbers in the race for increasing Assets under management (AUM). This further goes to show that the evaluation of compensation and bonuses for these fund managers should depend on the performance of the funds and not simply on AUM.


1. SEBI Circular no. SEBI/HO/IMD/DF3/CIR/P/2017/114 dated October 06, 2017.

2. SEBI Circular no. SEBI/HO/IMD/DF3/CIR/P/2020/194 dated October 05, 2020.

3. SEBI Circular no. SEBI/HO/IMD/DF3/CIR/P/2020/194 dated October 05, 2020.

4. SEBI Circular no. SEBI/HO/IMD/DF3/CIR/P/2020/197 dated October 05, 2020.

5. SEBI Circular no. SEBI/HO/IMD/DF3/CIR/P/2020/197 dated October 05, 2020.

6. SEBI Circular no. SEBI/HO/IMD/DF4/CIR/P/2020/202 dated October 08, 2020.

7. SEBI Circular no. SEBI/HO/IMD/DF4/CIR/P/2020/202 dated October 08, 2020.

8. SEBI Circular no. SEBI/HO/IMD/DF4/CIR/P/2020/202 dated October 08, 2020.

9. SEBI Circular no. SEBI/HO/IMD/DF4/CIR/P/2020/202 dated October 08, 2020.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.