What’s the story
The Securities and Exchange Board of India (SEBI) recently launched a new category of mutual funds called Life Cycle Funds.
These funds are designed to simplify the process of retirement planning and other financial goals for retail investors.
The innovative investment option is part of SEBI’s ongoing effort to rationalize and categorize mutual funds in India.
Open-ended mutual fund schemes
Life Cycle Funds are open-ended mutual fund schemes that follow a goal-based investing approach.
They invest across various asset classes such as equities, fixed income, gold, and silver ETFs, and InvITs.
The funds have a predetermined maturity date and follow a glide path for asset allocation as they near this date.
This means the allocation of assets in the fund changes over time to meet its investment goals.
How do they work?
Life Cycle Funds can have tenures starting from a minimum of five years and extending up to 30 years.
The asset allocation strategy is such that longer-maturity funds (like those with a 30-year tenure) start with a higher equity component (65-95%) and lower debt component (5-25%).
As the fund nears its maturity date, the equity component decreases while the debt component increases.
Asset allocation guidelines for different maturities
SEBI has issued asset allocation guidelines for Life Cycle Funds with different maturities.
For instance, a fund with a 30-year maturity will start with an equity component of 65-95% and a debt component of 5-25%.
The investment in gold/silver ETFs, ETCDs, and InvITs can range from 0 to 10%.
As the fund nears its maturity date (less than one year), it may be merged with another Life Cycle Fund having a similar maturity date.
Fund managers can only invest in high-quality debt instruments
For the debt component, fund managers can only invest in debt instruments with a credit rating of AA or higher. This is to ensure that Life Cycle Funds invest in high-quality debt instruments.
There is no lock-in period for investing in these funds but an exit load will be charged for early redemptions.
The exit load will be 3% for redemptions within one year, 2% within two years and 1% within three years of investment.
Gradual decline in equity exposure
SEBI has mandated that the name of a Life Cycle Fund should include its maturity date. This is to ensure investors can easily identify these funds.
Also, as the fund nears its maturity date, the equity component will decline. When there is less than five years to maturity, the maximum equity component can be 50%.
This gradual decline in equity exposure helps manage risk and ensure a smoother transition toward capital preservation as retirement approaches.