Introduction
The Securities and Exchange Board of India (“SEBI”) made a decisive move to enrich India’s investment ecosystem by introducing a new asset class known as Specialized Investment Funds (SIFs) through a circular dated February 15, 2025 (SEBI Circular No. SEBI/HO/IMD/IMD-PoD-1/P/CIR/2025/11). SIFs provide an investment avenue between Mutual Funds (MFs) which are widely accessible and regulated by the SEBI (Mutual Funds) Regulations, 1996, and Portfolio Management Services (“PMS”), which offer bespoke strategies for High NetWorth Individuals (“HNWIs”) and are regulated by the SEBI (Portfolio Managers) Regulations, 2020. SIFs are designed for semi-sophisticated investors, mandating a minimum investment requirement of ₹10 lakhs. SIFs provide access to higher-risk investments that require a strategy-intensive approach.
SEBI is gearing up to accept the first applications for SIFs from certain asset management companies (“AMCs”), pursuant to which evaluation of whether this new asset class can attract investors in India’s market and addressing regulatory considerations becomes necessary. SIFs are more flexible than MFs because they provide access to riskier strategies like leverage and derivatives, but they lack extensive risk management systems. This study examines how SIFs are shaped as a secure yet approachable investment vehicle in India’s changing financial market environment by looking at their institutional design, regulatory ramifications, and investor suitability.
Institutional Design of SIFs
SIFs are designed to cater to a category of semi-sophisticated investors. Clause 3 of SEBI Circular on SIFs stipulates a minimum investment of ₹10 lakhs. SIFs are positioned between high-investment PMS whose minimum investment is of ₹50 Lakhs and MFs which cater to a broader, retail investor base. This structure specifically targets individuals who are familiar with capital markets, providing them access to strategy-intensive investment opportunities. Unlike MFs, which do not allow leverage and restrict derivative exposure to hedging (Risk-Management Strategy), SIFs do not specifically restrict the use of derivatives, giving them more flexibility in their investment strategies. When compared to PMS, SIFs do not offer personalized strategies which makes them a standardized investment vehicle similar to that of a MF. It can be inferred that the regulatory features of SIFs combine the flexibility of PMS with the accessibility of MFs.
SEBI’s circular on SIFs reflects the hybrid nature of these funds. Clause 5 illustrates that SIFs are authorized to implement sophisticated strategies like long-short equity, tactical asset allocation, and sector-specific or debt-oriented rotations, unlike MFs.
The disclosure requirements within SIFs reflect a blend of elements from both PMS and MFs. Clause 6 of SEBI’s circular introduces a new document, namely Investment Strategy Information Document (“ISID).” This document calls for detailed and transparent information about the fund’s investment strategies, objectives, and risk profile. The ISID when compared to the Key Information Memorandum (“KIM”) under Regulation 29A of MFs, it becomes clear that KIMs focus more on basic scheme characteristics and risk metrics. ISID goes further in this regard, it mandates fund managers to elaborate on the rationale behind their investment strategies, set out clear investment objectives, and provide a multi-scenario risk assessment that evaluates optimal, median, and pessimistic outcomes. It can be derived that, SIFs aim to foster informed decision-making by investors which makes it similar to disclosure requirements under Reg. 22(3) of the PMS regulations.
Regulatory Conundrum
When comparing SIFs to existing investment options, their hybrid nature becomes evident. In contrast to Alternative Investment Funds (“AIFs”), which require a ₹1 crore investment and enforce multi-year lock-ins, SIFs offer HNWIs an attractive entry point with daily or weekly liquidity at a lower threshold. While AIFs focus on different goals such as Private Equity or Venture Capital, SIFs maintain regulatory oversight by concentrating on predetermined equity, debt, and hybrid strategies. SIFs differentiate themselves from traditional mutual funds by allowing tactical derivative usage and short-selling features, which were prohibited in MFs due to their restrictive investment policies or venture capital. SIFs maintain regulatory oversight by concentrating on predetermined equity, debt, and hybrid strategies. SIFs differentiate themselves from traditional mutual funds by allowing tactical derivative usage and short-selling features, which were prohibited in MFs due to their restrictive investment policies.
Investor Suitability is considered an important facet, Regulation 22(3) of PMS requires Portfolio managers to assess an investor’s financial goals and risk tolerance before onboarding them, with formal agreements outlining investment strategy and fiduciary duties. SEBI should introduce a formal suitability assessment process for SIFs, similar to Regulation 22(3) of PMS, to ensure that investors’ risk profiles align with the strategies employed. The need for investor profiling to assess financial goals, risk tolerance, and investment knowledge is emphasized in SEBI’s ( HYPERLINK “https://www.sebi.gov.in/legal/regulations/feb-2023/securities-and-exchange-board-of-india-investment-advisers-regulations-2013-last-amended-on-february-07-2023-_69215.html”Investment Advisers) Regulations, 2013 and also aligns with the post-2008 crisis reforms seen in regulations like HYPERLINK “https://www.esrb.europa.eu/pub/pdf/reports/20161005_potential_impact_leverage_ratio.en.pdf”MiFID II (European Framework). saw its need post the Financial Crisis of 2008.
SIFs also lack the contractual obligation that binds managers to fiduciary duties and are more strategy intensive, requiring engagement between the manager of the SIF and the investor to ensure better protection and accountability. While SIFs provide bi-monthly updates and standardized risk meters, these may not be adequate to address the complex risks associated with leverage, short-selling, and derivatives, which require more tailored, individualized risk management strategies. PMS is much more sophisticated in this regard since it tailors risk management strategies to each client’s personal goals and needs.
Systemic Risk Mitigation
SIFs allow leverage (unlike MFs), but their risk management and disclosure frameworks are less developed compared to PMS, which customizes risk management based on individual investor profiles. The 2008 Global Financial Crisis highlighted the dangers of excessive leverage and poor risk management, particularly in high-risk funds that lacked sufficient transparency and oversight. Many hedge funds, including Long-Term Capital Management (LTCM), failed during the crisis, highlighting the risks of excessive leverage, lack of transparency, and regulatory oversight, which can threaten financial systems. The lack of standardized risk reporting such as uniform risk metrics and performance disclosures made the hedge fund industry more vulnerable to systemic risks. After these incidents, several regulatory agencies, including SEBI, reassessed their risk disclosure strategies, but critics argue that their frameworks, such as bi-monthly portfolio updates, fail to mitigate systemic exposure risks.
European Undertakings for Collective Investment in Transferable Securities (UCITS) Rules demonstrate that diversification policies reduce sector-specific risks, offering stronger protection against market instability. Tight diversification criteria in UCITS laws reduce risk concentration within industries, protecting against sector-specific declines. These laws limit investments in any industry or asset class to reduce systemic shocks, which have effectively stabilized markets during financial instability. UCITS-compliant funds, which have strict diversification rules, outperformed less regulated investment vehicles during the 2010s European debt crisis by limiting sectoral concentration risk and reducing exposure to systemic shocks.
SEBI’s disclosure framework for SIFs is inadequate for risk-assessment of high concentration investment strategies, compared to UCITS’ regulatory effectiveness in the EU financial system. An effective risk assessment, matched with regulatory and contractual obligations, is essential for investment industry stability and market disruption prevention. SIFs bring innovation and systematic control to India’s wealth management scene. Investor education, tax treatment, and liquidity risk negotiation are key to their success. With careful execution, SIFs could democratize complex ideas and deepen markets, making India a model for developing nations.
Conditions for Investment
The SEBI (Mutual Funds) Regulations, 1996 establish a detailed framework for regulating investment limits and restrictions, which are similarly applied to SIFs. Reg. 44 lays down a diversified and balanced investment approach, protecting investor interests and promoting stability in the financial markets. The key provisions are reiterated below:
- Debt Investments:
SEBI permits investments of up to 20% of the total assets of a fund in bonds issued by the same firm. However, this is contingent upon obtaining permission from a trustee who possesses a minimum of 25% voting power. In the instance of investment in Government Bonds, there are no restrictions that provide flexibility for fund managers.
- Equity Investments:
For equity investments in a single firm, SEBI has imposed a limit of 10% of total Net Asset Value (NAV”). This ensures sufficient diversification and minimizes the risk exposure to any one company. Additionally, a maximum of 15% is allowed for voting shares in any corporation, which supports broader, more diversified investments in the equity space. - Investments in Real Estate and Infrastructure:
Regulation 44(4) permits investment up to 20% of the total NAV in Real Estate Investment Trusts (“REITs”) and Infrastructure Investment Trusts (“InvITs”), with no more than 10% in a single trust. This promotes diversified exposure to real estate and infrastructure sectors, which are essential for balanced portfolio management.
- Derivatives:
SEBI allows MFs (and by extension, SIFs) to allocate up to 100% of their NAV in derivatives, but this is contingent upon strict risk management protocols. These protocols are designed to mitigate the exposure and ensure that the use of derivatives does not lead to excessive risk accumulation.
- Risk Management and Diversification:
Regulation 44(5) ensures a diversified portfolio by imposing limits on sectoral investments. This ensures that no sector or asset class dominates the portfolio, promoting a balanced risk exposure. Whereas Reg. 44(6) mandates that the fund’s investment strategy must maintain a diversified portfolio, protecting investors from overexposure to one type of asset or industry. This provision is essential for managing systemic risk and ensuring that the SIF portfolio remains stable even during periods of market volatility.
Conclusion
This paper provides a comparative perspective with PMS and MFs and analyses the operational mechanics and regulatory design of SIFs effectively. Although SIFs are recognized to be innovative and directly promote sectoral growth, they draw attention to certain regulatory gaps. The paper specifically points out the premature nature of investor suitability assessment and risk management surrounding the SIFs framework. If these facets of SIFs are better developed, it would guarantee investor protection and market stability and also the democratization of complex investment strategies which would indeed facilitate economic development.
This blog is written by Rohan Gaddam and John Scaria, students, NALSAR University of Law, Hyderabad.
