Implication of residual investments on core portfolios

The Securities and Exchange Board of India (SEBI) recently allowed equity funds to invest up to 35% of their residual portfolio in non-equity investments. In this article, we look at the implication of this regulation on your core portfolios.

When you invest in an equity fund, you expect to get equity exposure. Take large-cap active funds.

According to SEBI’s regulation, such funds must invest not less than 80% in large-cap stocks. That gives these funds room to wander into mid-cap and small-cap space. Large-cap active funds typically invest in mid-cap stocks for the residual allocation (not more than 20%). The recent SEBI regulation allows these funds to also invest in gold ETFs, silver ETFs and Infrastructure Investment Trusts (InvITs). The rationale is that gold and silver could perform well when equity market declines sharply.

So, investing in non-equity investments could provide these funds a way to stabilize their portfolios when equity market turns volatile. Equity funds may or may not choose to invest in these non-equity investments. How does this regulation impact your investments? Take core portfolios that you create to achieve your life goals. You may have taken exposure to large-cap active funds and bank deposits to fulfil your equity and bond allocations. In addition, you may have also invested in gold and silver ETFs in the belief that the prices of these metals will increase steadily over the long term. Alternatively, you may be actively trading in gold and silver ETFs as part of your satellite portfolio. But what if the large-cap active fund you invested in takes also exposure to gold and silver ETFs?

You may have unintentionally created more exposure to these metals- your direct exposure to such ETFs and indirect exposure through the active equity funds. Though the investment in non-equity does not affect the tax treatment of your investments in these equity funds, your asset allocation can become somewhat skewed.

Conclusion

Despite the SEBI regulation, equity funds have typically maintained their equity allocation. That may change in the future. If you are concerned about equity funds taking exposure to non-equity investments, you can consider investing in index funds or equity ETFs. As passive products, index funds and equity ETFs are required to mirror their benchmark index. That means their portfolio will contain the same stocks in the same weights as the benchmark index. So, you will get your intended exposure to an equity index.

(The author offers training programmes for individuals to manage their personal investments)