SEBI’s proposal to allow Indian mutual funds to invest in overseas funds with Indian exposure: Explained

SEBI proposes framework for Indian mutual funds to invest in overseas funds with limited Indian exposure, seeking public feedback.

The story so far: Markets regulator Securities and Exchange Board of India (SEBI) on May 17 floated a consultation paper proposing a framework for facilitating investments by domestic mutual funds (MFs) in their overseas counterparts, or unit trusts (UTs) that invest a certain portion of their assets in Indian securities. It observed that the existing framework does not explicitly permit domestic MFs to invest in overseas MF/UTs with exposure to Indian securities. “Therefore, it is understood that many mutual funds in the industry avoid investing in such overseas MF/UTs that have any kind of exposure to Indian securities,” it said. Comments about the proposed framework are solicited until June 7.  

Noting India’s strong economic growth prospects, SEBI observes that Indian securities offer an attractive investment opportunity for foreign funds. SEBI says this has led to several international indices, exchange traded funds (ETFs), MFs, and UTs allocating a part of their assets towards Indian securities. For perspective, in a consultation paper, MSCI Emerging Markets Index was noted to hold 18.08% exposure to Indian securities. Similarly, JP Morgan’s Emerging Markets Opportunities Funds held 15% in Indian investments, as per their latest factsheet (as on March 31, 2024).

Indian mutual funds, somewhat conversely, diversify their portfolios by launching ‘feeder funds’ which invest in overseas instruments such as (units of) MF, UTs, ETFs and/or index funds. Other than diversification, it eases the path to make global investments. However, ambiguity remains about investments which have Indian exposures, which deters domestic MFs from investing in these instruments which in turn invest in a basket of countries as a means of diversification and enhancing returns.  

SEBI’s cumulative assessment sees merit in potentially allowing investments of this kind with “limited exposure to Indian securities.” Within the proposed framework, the markets regulator also intends to place essential safeguards which would keep the Indian instruments “true to their label” and enable investors to take desired exposure in overseas securities. It is essential to note that, if the fund has significant exposure to Indian securities, the purpose of making an overseas investment is defeated. Secondly, an indirect investment through an (indirect) overseas investing instrument is not cost-effective for an end-investor in comparison to a direct investment made in Indian securities — thus, fulfilling no purpose.  

Significantly, the upper limit for investments made by overseas instruments (in India) has been capped at 20% of their net assets. That is, overseas instruments being considered must not have an exposure of more than 20% in Indian securities. Deeming the cap “appropriate,” SEBI explains that this would help “strike a balance between facilitating investments in overseas funds with exposure to India and preventing excessive exposure.” 

The markets regulator has also sought that Indian mutual funds ensure contributions of all investors of the overseas MF/UT is pooled into a single investment vehicle. They must not be in a side-vehicle, that is, a parallel instrument alongside the main instrument with varying exposure. This again is essential for the invested money (of these domestic mutual funds) to attain its objective. Other than this, Indian mutual funds must also ensure that all investors of the overseas instrument are receiving gains proportionate to their contribution – and in no order of preference.  

Other than this, Indian mutual funds would also have to ascertain that the overseas instrument is managed by an “officially appointed, independent investment manager/fund manager” who is “actively involved in making all investment decisions for the fund.” SEBI stresses that these investments are to be made autonomously by the manager without any influence from the investors or undisclosed parties.