Regulated Flexibility: SEBI introduces Specialized Investment Funds for Wealthy Investors

[Anasruta is a student at National University of Advanced Legal Studies.]

The Securities and Exchange Board of India (SEBI) has introduced specialized investment funds (SIFs) through amendments to the SEBI (Mutual Funds) Regulations 1996, effective 1 April 2025, to address the evolving needs of high-net-worth investors. SIFs are meant to fill the gap between mutual funds (MFs) and high-risk portfolio management services (PMS). SIFs are targeted at HNIs who are looking for sophisticated investment strategies with moderate flexibility. This is a big change in India’s investment landscape, offering a platform for structured but sophisticated wealth management. Key legislative amendments include the addition of Chapter VI-C to the Mutual Funds Regulations, which outlines the regulatory framework for SIFs.

Eligibility and Regulations

Under Regulation 49W, SIFs can be launched only by registered mutual fund houses and should have at least INR 10,000 crores 3-year average assets under management (AUM), or be led by a Chief Investment Officer who has at least 10 years of experience in handling a minimum INR 5,000 crores and a fund manager with minimum 3 years of experience of managing a minimum INR 500 crores AUM. The sponsor or asset management company (AMC) should not have faced any regulatory proceedings, investigations, or penalties under Sections 11, 11B, or 24 of the SEBI Act, 1992, within the preceding 3 years.

To provide transparency and differentiation, as per Regulation 49AB, SIFs will have to operate under a separate brand and logo, independent of their parent mutual fund, but can use the words “offered by ABC Mutual Fund” for the first five years to gain credibility. A separate website or webpage is required to further differentiate SIFs from regular MF schemes.

Investment Strategies and Risk Management

SIFs will have 3 investment strategies. The equity-oriented strategy will use long-short strategies, where fund managers will speculate on rising stocks and short-falling ones, with a minimum of 80% equity exposure. The debt-oriented strategy will use sector-specific debt strategies, like focusing on auto or banking sectors but with single-sector exposure limits to avoid concentration risk. The hybrid strategy will allow dynamic shifting between equities, debt, derivatives, and commodities, offering investors a diversified portfolio. Redemption options will vary based on strategy; equity strategy will have daily redemption, and debt/hybrid strategy will have weekly redemption to balance liquidity and fund manager flexibility.

As per Regulation 49X, investors can enter SIFs with a minimum amount of INR 10 lakhs per PAN, over and above their normal mutual fund holdings. Systematic investment plans are allowed, but the investor has to maintain the INR 10 lakh level. If market losses reduce the investment below this level, redemption is required at full value. For risk control, SEBI has asked for a 5-step risk meter that has to be revised monthly and published on AMC and the Association of Mutual Funds in India (AMFI) websites through monthly risk-band disclosures. 

SIFs also allow unhedged short positions of up to 25%—never seen before for SEBI-regulated products, excluding PMS and AIFs. Debt exposure limits have a 12% cap on A-rated issuers and a 25% net asset value limit on sectoral debt investment. For liquidity, close-ended or interval SIFs will have to list units on stock exchanges, and the redemption notice period will be 15 working days, offering a disciplined exit opportunity. Distributors must pass the NISM Series-XIII certification to handle these complex products.

SIFs v/s Other Investment Options

SIFs differ from alternative investment funds (AIFs), mutual funds and PMS. While AIFs require a minimum investment of INR 1 crore for Category III funds, SIFs require a lower amount of INR 10 lakhs, making it more convenient for HNIs. AIFs allow a wider range of investment mandates like venture capital and private equity, while SIFs are pre-defined equity, debt, and hybrid strategies. In terms of liquidity, SIFs have daily or weekly redemption facilities, while AIFs have lock-ins of 3 years or more. SIFs have bi-monthly portfolio disclosure and a standardized risk meter, while AIFs have quarterly disclosure without standard risk labels.

Unlike mutual funds, SIFs allow advanced techniques like short-selling and derivative trading, which is not allowed in regular MFs. While retail investors with no minimum entry criterion are served by mutual funds, SIFs target HNIs. Unlike PMS, which offers customized portfolios for a minimum investment of INR 50 lakhs, SIFs offer structured strategies for a lower entry point of INR 10 lakhs.

Why SIFs are Big in Wealth Management

The launch of SIFs is significant as it brings HNIs the benefit of advanced investment strategies like short-selling without the high hurdles or illiquidity of AIFs and PMS. SEBI ensures transparency through risk meters and scenario analysis and limits derivative exposure and debt ceilings to protect investors. This disciplined approach combines sophistication with safety. Hence, SIFs are the preferred choice for investors who want to maximize their investment portfolio.

In the long run SIFs will be good for India’s wealth management industry as it will attract HNIs looking for returns higher than mutual funds but lower risk exposure than PMS or AIFs. Through equity long-short strategy and sector rotation, SIFs can potentially boost market liquidity and price discovery, especially in mid-cap stocks and derivatives. However, success depends on fund managers to navigate the volatile markets and adhere to SEBI’s exposure caps like 25% of the sectoral debt limit. Increased competition among asset managers will lead to innovation in structured products and the deepening of Indian capital markets.

Global Lessons for SIFs

SIFs can learn from international investment products like hedge funds, active managed Exchange-Traded Funds (ETFs), and undertaking collective investment in transferable securities (UCITS) in Europe. Hedge funds in the US and Europe have delivered strong returns for years but were heavily leveraged and non-transparent, which led to blow-ups in 2008. SIFs should avoid excessive dependence on derivatives and focus on transparency, which has been covered by SEBI through risk disclosure mandates.

Active managed ETFs in financial hubs like Hong Kong and Singapore have shown that while active strategy can give growth, management fees tend to eat into the returns over time. SEBI will have to keep a tab on fee structures to ensure SIFs remain economical for the investor. The European UCITS regime has a balanced formula for investor protection through rules on diversification. SIFs reflect this principle with sectoral debt exposure limits but will need strict enforcement to avoid concentrated market risk. After Japan’s Tokkin funds in the 1990s which imploded due to speculative bets and governance issues, SIFs should prioritize prudent risk management to avoid similar disasters.

Challenges and Risks for SIFs

Although promising, SIFs also have challenges and risks. One of the biggest is regulatory compliance. The need for a clear brand identity and high AUM hurdles may exclude smaller AMCs from participating, curbing competition. The liquidity risks of SIFs need to be addressed. While flexibility is provided through daily and weekly redemptions, rapid large-scale investor withdrawals in falling markets—like the liquidity crisis faced by US liquid alternative funds in 2020—can destabilize the portfolio and lead to fire sales. Another challenge is investor confusion. 

Most HNIs may not be aware of complex strategies like derivatives-based short-selling, which can lead to risk misinterpretation and possible disputes with respect to mis-selling. Tax uncertainty is another issue, as it is not clear whether SIFs will be taxed as equity or debt funds. If taxed as debt funds, short-term capital gains (for periods less than 3 years) may be taxed at more than 30%, which can deter investors from entering the SIF market. Economic risks are also a threat as market volatility can be amplified through concentrated derivative positions. The 2021 Archegos Capital collapse due to unhedged exposure in swap-based derivatives is an example of unmonitored exposure, which SEBI needs to be proactive in avoiding.

The Way Forward for SIFs

SEBI and AMFI must ensure that risk communication continues to be investor-centric for SIFs to work. Reducing the complexity of the Risk-Band metric will prevent complacency and lead to well-informed decisions. Clarifying taxation policies to bring SIFs in line with investor-friendly frameworks, like reducing long-term capital gains tax rates for equity-focused approaches, is essential for its continued attractiveness. Adopting global best practices like stress testing standards seen in the European UCITS liquidity regime will prevent financial instability.

On the right track, SIFs may bring advanced investment techniques to India's expanding HNI base and establish a model for emerging markets. However, neglecting world lessons or discounting major threats may repeat the mistakes of the past, and ultimately erode investor confidence in this promising new channel.