Mon Sep 23 15:04:06 UTC 2024: ## SEBI’s Scheme Categorization Rules: A Boon for Investors, But a Barrier to Innovation?

Seven years after the Securities Exchange Board of India (SEBI) implemented its landmark scheme categorization regulation, a growing concern is emerging: the rules that were meant to simplify investment choices may be hindering innovation and limiting investor options.

The 2017 regulation categorized mutual fund schemes into 36 distinct categories, with strict portfolio boundaries and a one-scheme-per-category rule for each Asset Management Company (AMC). While this led to increased transparency and made it easier for investors to compare and choose funds, the framework is now facing challenges as mutual fund assets have grown exponentially.

**The Winner’s Curse of Success:** Popular schemes are becoming too large to sustain their performance. The massive inflows have strained the capacity of the cash market, leading to higher impact costs and forcing funds to dilute their portfolios. This, in turn, is impacting returns and creating a “winner’s curse” scenario where successful funds struggle to maintain their performance.

**The Rise of Thematic and Passive Funds:** The one-scheme-per-category rule has led to a surge in thematic and passive fund launches, as AMCs seek to attract investors without exceeding their category quota. While these options provide diversification, they are not without risk and may not always be suitable for all investors.

**Innovation Stagnates:** The rigid categorization framework has stifled innovation within the mutual fund industry. AMCs are reluctant to launch new products that might fall outside the 36 categories, leading to a dearth of sophisticated and risky products that cater to the evolving needs of investors.

**A Call for Flexibility:** Experts argue that SEBI should consider relaxing the one-scheme-per-category rule, allowing AMCs to launch additional schemes within categories where they have a proven track record. This could be accompanied by a tiered Total Expense Ratio (TER) structure to prevent cloning.

The future of mutual funds in India hinges on SEBI’s ability to find a balance between investor protection and promoting innovation. The current scheme categorization framework, while beneficial in its early years, is now facing a critical juncture. A timely review and necessary adjustments are essential to ensure the continued growth and success of the mutual fund industry in India.

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