CALIBRATED LIBERALISATION IN SEBI'S 2026 MUTUAL FUND REFORMS

This post is authored by Srijan Pandey and Sharad Dhruw, second-year B.A. LL.B (Hons.) students at Hidayatullah National Law University, Raipur.

INTRODUCTION

By the beginning of 2026, the collective value of mutual fund assets has gone beyond ₹ 81.01 lakh crore, which has made mutual funds among the top ways to save money for households. With the mutual fund industry in India witnessing sustained growth and establishment of retail investment, the Securities and Exchange Board of India (SEBI) has taken a more facilitative approach of regulation with a view of ensuring the market efficiency and protection of the investors. This change is reflected in the Circular on Categorization and Rationalization of Mutual Fund Schemes dated 26 February 2026 which marks a shift from a strict and rigid classification system to a more flexible approach based on clear disclosure, allowing investors to make informed decisions. By this circular, SEBI has brought about reforms to enhance scheme differentiation and rationalisation of outdated categories. In addition to this, regulator has broadened the range of permissible asset allocation in mutual fund portfolios.

The author in this article discusses this calibrated liberalisation strategy in the light of reformation measure of SEBI in the year 2026. It begins by reviewing the major changes in regulations, in light of the SEBI (Mutual Funds) Regulations (Regulation), 1996 and the Securities and Exchange Board of India Act (SEBI), 1992 after which it assesses the structural issues that the changes bring about in its implementation and finally provides safeguards based on international regulatory practice.

DECODING THE REFORM

The Circular on Categorization and Rationalization of Mutual Fund Schemes forms part of SEBI’s broader effort to enhance transparency and efficiency in the mutual fund sector. Issued under Regulations 25 and 27 of the SEBI (Mutual Funds) Regulations, 1996, and Section 11 of the SEBI Act, 1992, it seeks to improve scheme differentiation, rationalise outdated categories, and expand permissible asset allocation. Reflecting a model of calibrated liberalisation, the reforms aim to balance fund managers’ operational flexibility with investor protection, and are embodied in three key measures proposed by the circular.

First, SEBI has incorporated minimum overlap of the portfolio between sectoral or thematic schemes and other equity schemes of the same asset management company (AMC). These funds are marketed as sector-specific investment vehicles intended to capture opportunities within particular industries. However, in practice, many such schemes closely resembled diversified equity funds offered by the same AMC, thereby weakening their distinct investment identity. To address this, the regulator has imposed a 50% ceiling on portfolio overlap, calculated on the basis of ISIN-level holdings, in order to reinforce the “true-to-label” principle, which requires that scheme names accurately reflect their underlying portfolios. This reform aligns with SEBI’s disclosure-based framework under the 1996 Regulations, emphasising transparency in scheme composition. Moreover, a similar concern is reflected in international regulatory frameworks. Article 52 of the UCITS Directive lays down diversification rules by limiting exposure to a single issuer and preventing excessive concentration within portfolios. These safeguards are intended to ensure genuine diversification and avoid the illusion of diversification, thereby promoting balanced risk distribution and protecting investors.

Second, the circular reforms the goal-based investment products through the ending of the solution-oriented schemes such as Retirement Funds and Children Funds and introduction of the Life Cycle Fund. These plans had initially been created in Indian regulatory regime laws as a way of encouraging long term investment behaviour by having lock-in it, but there was a gradual lack of differentiation between these types of plans and hybrid funds. The appearance of the Life Cycle Funds can be viewed as an indicator of the transformation that SEBI underwent stiffer but more flexible in terms of long-term investing. These funds follow a glide-path asset allocation strategy that reduces equity exposure as the investment horizon nears maturity, aligning portfolio risk with investor objectives; however, such strategies may involve variability in outcomes, behavioural risks for investors, and potential mis-selling where perceived safety may not reflect actual risk.

Third, the circular increases the authorised asset allocation system of mutual funds involved with equity funds so as to invest a maximum of 35% of their non-core exposure in assets like gold funds, silver funds, and some debt instruments. This reform was introduced because the SEBI has the power to set investment limits and portfolio rules for mutual funds. This reflects a clear shift from strict portfolio categories to more flexible asset allocation. This allows fund managers to respond better to changing market risks, while still following regulatory rules. In contrast, the U.S. framework under the Investment Company Act of 1940 adopts a principles-based approach, relying on fund classification and disclosure rather than fixed quantitative caps. Simultaneously, the framework preserves the core equity allocation requirements under SEBI’s categorisation norms, and thus will not erode the much-needed nature of equity schemes.

CHALLENGES IN THE CALIBRATED LIBERALISATION FRAMEWORK.

Although the reforms that have been enacted by SEBI show the liberalisation of the regime governing the mutual funds in a calculated manner, issues of whether such flexibility can provide meaningful investor protection have remined in question. The move towards a more disclosure-based and flexible regime, despite the facilitative nature of the regime to market efficiency, presents structural challenges as to whether disclosure alone can adequately substitute for substantive regulatory safeguards in a rapidly expanding retail-driven market.

First, the portfolio overlaps limits, while reinforcing the “true-to-label” principle, have confined to intra-AMC level only. This creates a regulatory gap whereby investors holding schemes across multiple asset management companies (AMCs) may still face high portfolio similarity despite compliance at the individual AMC level. This concern is particularly relevant in light of investor behaviour, as diversification across AMCs is often assumed to reduce overlap. However, this assumption may be misplaced, as many retail investors invest through systematic investment plans (SIPs) or may unknowingly duplicate exposure across similar schemes, thereby undermining effective diversification.

It was revealed that some equity mutual fund schemes in various fund houses still have significant concentration in a small group of large-cap stocks and as such they give an impression of diversification to the retail investors. These developments highlight the weakness of scheme-level restrictions on overlap in the tackling of portfolio concentration on the level of the investor.

In order to cope with these issues, SEBI can contemplate the possibility of supplementing their current framework with even tougher diversification rules, which are not restricted by intra-AMC issues. The international regulatory framework is stringent maximum concentration on issuers as enforced in the UCITS Directive in the European Union to make certain that collective investment schemes are diverse not only in terms of securities but also in sector. The overlapping limits within the type of sector exposures or issuer-focused exposures can be reinforced by adding the same levels of exposure thresholds to the Indian regime and maintaining the flexibility of the reforms. This has also been emphasised in Franklin Templeton Trustee Services Pvt. Ltd. v. Amruta Garg, where the Supreme Court held that trustees play a fiduciary role in safeguarding investors’ interests and ensuring prudent management of mutual fund schemes, including oversight of investment decisions. The Court’s ratio underscores that investor protection is not merely procedural but substantive in nature. Thus, regulation must go beyond formal compliance to ensure effective protection of investors, particularly in matters such as diversification and risk management.

Second, the emergence of Life Cycle Funds raises concerns over unstandardised glide-paths. The discretion granted to asset management companies to make asset allocation path will potentially cause a high degree of difference in the scope of risk taken by schemes with almost similar maturity horizons as a result of which comparability is not achieved which creates the likelihood of investor misperception.

To minimize the risk, SEBI can adopt the regulatory approach in the U.S. securities and Exchange commission (SEC), specifically in its guidelines on target-date funds that are issued in accordance with the Investment Company Act, 1940. The SEC framework focuses on straightforward, standardised reporting on glide-path plans, comprising of assets allocation at various time periods and corresponding risk profiles. Such minimum glide-path requirements aim to reduce information asymmetry and enhance investor protection by ensuring predictability in risk exposure. In this context, targeted disclosures, that is, disclosures specifically designed to convey a fund’s investment strategy and risk trajectory are emphasised to enable more informed investor decision-making.

Third, the increase in allowable assets to be used in equity funds is problematic in terms of benchmark integrity and a good representation of risks. This could undermine the soundness of the conventional equity benchmarks and blur the actual risk-return profile of the fund as non-equity instruments such as commodities and debt can be included in the equity-based schemes. This difficulty indicates a larger problem with the regulation of multi-asset funds, where the effectiveness of performance measurement mechanisms to assess a diversified structure of a portfolio might be insufficient. In these situations, investor might be subjected to risks which are not completely shown in benchmark comparisons thus compromising informed decision making.

A pertinent solution may be drawn from the EU Benchmarks Regulation (EU) 2016/1011, which provides parameters to ensure benchmarks reflect underlying economic reality. However, such an approach may be limited in practice as it does not sufficiently account for compliance costs and potential market impact, rendering it largely normative. The regulation focuses on the transparency of methodology and the integrity between the composition of benchmarks and the assets under follow-up. Using the same principle, SEBI may require that diversified equity scheme benchmarks be applied using composite-based or methodology-based benchmarking, so that the benchmarks do represent the underlying asset allocation and risk exposure.

CONCLUSION

The reforms introduced by SEBI mark a shift towards calibrated liberalisation, balancing enhanced portfolio flexibility with investor protection. However, their effectiveness depends on whether disclosure-based flexibility is supported by substantive safeguards. As the limitations relating to intra-AMC overlap, unstandardised glide-paths, and benchmark distortions indicate, regulatory design must move beyond formal compliance to address structural risks in investor decision-making. Accordingly, the success of this framework lies in integrating stricter diversification norms, standardised disclosure mechanisms, and robust benchmarking practices, ensuring that flexibility does not dilute transparency or undermine investor protection.