SEBI scheme rationalisation circular 2017
The SEBI scheme rationalisation circular of 2017, formally SEBI circular SEBI/HO/IMD/DF3/CIR/P/2017/114 dated 6 October 2017, is the most consequential structural intervention in the history of the Indian mutual fund industry. It mandated a comprehensive categorisation and rationalisation of open-ended mutual fund schemes, establishing 36 defined scheme categories (subsequently revised to 37, and later updated to reflect new category types) with precise investment mandates tied to verifiable financial parameters. Each AMC was permitted to operate only one scheme per category (with limited exceptions). The circular required all AMCs to merge or convert their existing schemes into the prescribed category framework within six months of SEBI’s acceptance of each AMC’s rationalisation proposal. The framework reduced the number of open-ended schemes from over 2,000 to approximately 550 across 44 AMCs by early 2018 and provided investors with the ability to compare schemes across AMCs within a category on a like-for-like basis. The circular is grounded in SEBI (Mutual Funds) Regulations, 1996 and was issued by the SEBI Investment Management Department.
Background
Pre-2017 proliferation problem
Prior to October 2017, the Indian mutual fund industry operated with more than 2,000 open-ended schemes across 44 AMCs. Key problems included:
- Definitional inconsistency: Multiple AMCs had schemes labelled “large-cap” that held significantly different proportions of large-cap stocks, making peer comparison impossible.
- Style drift: Schemes frequently shifted their investment mandate over time without corresponding name changes, misleading investors about their actual risk profile.
- Excessive proliferation: A single AMC could operate 8–10 “diversified equity” schemes that were essentially identical in mandate, adding no meaningful choice but confusing investors.
- Benchmark gaming: Schemes selected benchmarks that they were likely to outperform rather than benchmarks representative of their actual investment universe.
- Disclosure opacity: The Scheme Information Document (SID) allowed wide minimum-maximum asset allocation bands, giving fund managers latitude to range well outside the scheme’s implied mandate.
Regulatory rationale
SEBI’s Board considered the problem in early 2017 and concluded that investor confidence and market development required standardised, enforceable category definitions. The circular emerged from an extensive consultation process with AMCs, trustees, and AMFI.
The 36/37 category framework
The circular defines categories across five broad groups:
1. Equity schemes (10 categories)
| Category | Definition |
|---|---|
| Multi Cap Fund | Minimum 65% in equity; minimum 25% each in large-, mid-, and small-cap (post 2020 amendment) |
| Large Cap Fund | Minimum 80% in large-cap stocks (top 100 by market cap, AMFI list) |
| Large & Mid Cap Fund | Minimum 35% each in large-cap and mid-cap |
| Mid Cap Fund | Minimum 65% in mid-cap stocks (101st to 250th by market cap) |
| Small Cap Fund | Minimum 65% in small-cap stocks (251st rank onwards) |
| Dividend Yield Fund | Minimum 65% in high dividend yield stocks |
| Value Fund / Contra Fund | An AMC may offer either Value or Contra, not both; minimum 65% in equity |
| Focused Fund | Maximum 30 stocks; minimum 65% in equity |
| Sectoral/Thematic Fund | Minimum 80% in sector/theme; multiple sectoral/thematic funds permitted |
| ELSS | Minimum 80% in equity with 3-year lock-in; tax benefit under Section 80C |
2. Debt schemes (16 categories)
| Category | Macaulay duration/definition |
|---|---|
| Overnight Fund | Investments in overnight securities only |
| Liquid Fund | Up to 91-day maturity; no structured obligations |
| Ultra Short Duration Fund | Macaulay duration 3–6 months |
| Low Duration Fund | Macaulay duration 6–12 months |
| Money Market Fund | Money market instruments; up to 1-year maturity |
| Short Duration Fund | Macaulay duration 1–3 years |
| Medium Duration Fund | Macaulay duration 3–4 years |
| Medium to Long Duration Fund | Macaulay duration 4–7 years |
| Long Duration Fund | Macaulay duration > 7 years |
| Dynamic Bond | Across durations; no specific Macaulay duration |
| Corporate Bond Fund | Minimum 80% in AA+ and above corporate bonds |
| Credit Risk Fund | Minimum 65% in AA and below corporate bonds |
| Banking and PSU Fund | Minimum 80% in banking and PSU bonds |
| Gilt Fund | Minimum 80% in government securities |
| Gilt Fund with 10-year constant duration | Minimum 80% G-Secs; Macaulay duration ≥ 10 years |
| Floater Fund | Minimum 65% in floating-rate instruments |
3. Hybrid schemes (7 categories)
| Category | Definition |
|---|---|
| Conservative Hybrid Fund | 75–90% debt; 10–25% equity |
| Balanced Hybrid / Aggressive Hybrid Fund | An AMC may offer either balanced (40–60% each in equity/debt) or aggressive hybrid (65–80% equity); not both |
| Dynamic Asset Allocation / BAF | Asset allocation managed dynamically; no fixed bands |
| Multi Asset Allocation | Minimum 10% each in at least 3 asset classes |
| Arbitrage Fund | Minimum 65% in arbitrage strategies |
| Equity Savings | Minimum 65% equity; minimum 10% debt; uses hedging |
4. Solution-oriented schemes (2 categories)
- Retirement Fund: Minimum 5-year lock-in.
- Children’s Fund: Lock-in until child attains age 18 or 5 years, whichever is earlier.
5. Other schemes (2 categories)
- Index Funds/ETFs: Multiple permitted per AMC.
- Fund of Funds (FoF): Overseas FoFs and domestic FoFs; multiple permitted per AMC.
The “one scheme per category” rule
The most commercially impactful provision of the circular is the rule that each AMC may operate only one scheme per category for the categories other than Sectoral/Thematic, Index/ETF, and FoF. This required:
- AMCs with two or more large-cap funds to merge all but one into a single surviving scheme.
- AMCs with multiple diversified equity funds to merge or convert them.
- Every merger required SEBI approval under the scheme merger and conversion rules and an exit window for unitholders of the merging schemes.
SEBI set a deadline of 28 February 2018 for submission of rationalisation proposals, with the actual mergers/conversions completed by May 2018 in most cases.
AMFI large-cap/mid-cap/small-cap classification
A critical enabling element of the circular is the AMFI list of stocks by market capitalisation, updated every six months (January and July). AMFI ranks all BSE-listed stocks by average full market capitalisation over the preceding six months:
- Large-cap: 1st to 100th in ranking.
- Mid-cap: 101st to 250th in ranking.
- Small-cap: 251st rank and beyond.
Fund managers must align their portfolio to these definitions. If a stock previously classified as large-cap drops to 151st rank in the AMFI update, a large-cap fund holding it must divest within the grace period (typically two months from the AMFI list publication).
Amendments post-2017
Multi-cap reclassification (2020)
SEBI circular SEBI/HO/IMD/DF3/CIR/P/2020/236 dated 6 November 2020 amended the multi-cap fund definition to mandate minimum 25% each in large-cap, mid-cap, and small-cap, eliminating the latitude fund managers previously had to hold mostly large-cap stocks in a “multi-cap” fund. See SEBI multi-cap reclassification 2020.
Flexicap fund (2020)
To address the loss of flexibility in multi-cap funds, SEBI introduced the “Flexicap Fund” category in November 2020, requiring only minimum 65% in equity with no sub-asset class constraints.
ESG category (2021)
SEBI added an ESG (Environmental, Social, Governance) Thematic scheme category, subsequently upgraded to a full ESG framework; see SEBI MF ESG disclosure framework.
Market impact
The 2017 rationalisation had profound market-level effects:
- Comparability: Large-cap fund TERs fell as performance comparison across AMCs became precise; no fund can obscure underperformance by holding a different mix of stocks labelled “large-cap.”
- Scheme consolidation: From over 2,000 open-ended schemes pre-2017, the number fell to approximately 550 by end-2018, reducing investor confusion.
- AUM flows: Merger-related exit windows generated some temporary redemptions (investors in merging schemes exited without load), but the long-term effect was increased AUM concentration in the surviving schemes.
- Benchmark governance: AMCs were required to select benchmarks consistent with the category definition; custom or exotic benchmarks were disallowed.
- Style box discipline: Ongoing AMFI market cap list updates impose continuous discipline on fund managers to stay within their mandated style box.
Enforcement
SEBI has issued show-cause notices and sought explanations from AMCs where:
- A large-cap fund’s exposure to mid-cap stocks exceeded the permissible limit between AMFI list updates.
- A credit risk fund’s investment in AA+ bonds exceeded the 35% non-AA-and-below limit.
- An AMC was found to have re-launched a category with a new label after merging the original scheme, effectively circumventing the one-scheme-per-category rule.
See also
- Mutual fund
- SEBI (Mutual Funds) Regulations, 1996
- SEBI Investment Management Department
- SEBI multi-cap reclassification 2020
- SEBI scheme merger and conversion rules
- Riskometer framework (India)
- Scheme Information Document
- TER regulation and slabs
- SEBI MF ESG disclosure framework
- Mutual fund industry in India
References
- SEBI Circular SEBI/HO/IMD/DF3/CIR/P/2017/114, 6 October 2017, Categorisation and Rationalisation of Mutual Fund Schemes.
- SEBI Circular SEBI/HO/IMD/DF3/CIR/P/2020/236, 6 November 2020, Multi-cap reclassification and Flexicap introduction.
- SEBI (Mutual Funds) Regulations, 1996, Chapter IV.
- AMFI, “Categorisation of stocks, large/mid/small cap”, amfiindia.com, January and July updates.
- SEBI Master Circular SEBI/HO/IMD/IMD-PoD-1/P/CIR/2024/137, 27 May 2024.