MF Lite: SEBI's lighter route for passive fund houses

MF Lite is a framework inside SEBI's mutual fund rules for AMCs that only run passive schemes. A passive scheme does not try to beat the market. It copies an index such as the Nifty 50, so a fund manager does not pick stocks. The two common forms are index funds, which anyone can buy from the fund house, and exchange traded funds (ETFs), which trade on a stock exchange.

SEBI's board approved the idea in September 2024, and secondary sources say the amendment to the Mutual Funds Regulations was notified in December 2024. Before this, any new fund house needed the full licence, with larger capital and track record rules designed for active funds. A live case: 1 Finance, a Mumbai-based personal finance advisory firm, received in-principle approval from SEBI to set up an AMC under the MF Lite framework, aiming at index funds and ETFs, subject to final registration.

The main differences are in the entry norms and in what the AMC may do. An MF Lite AMC may run only passive schemes. It generally cannot take up other business, and a subsidiary needs SEBI's prior approval. In return, the capital it must hold is lower than for a full AMC, and the sponsor test is easier to meet.

Sponsors can qualify through one of two routes, as summarised by law firms: a track record of positive net worth and profit over several years, or a higher amount of capital where the track record is missing. Sources differ on the exact net worth figures and the sponsor's minimum share, so the notified text on SEBI's website should be read for the numbers.

The reason SEBI created the route was to widen choice. Passive investing needs less research and fewer people, so the rules for such an AMC do not need to be as heavy as those for a fund house that picks stocks. SEBI still checks that the sponsor is a fit and proper person, that systems for valuing and reporting funds are in place and that an independent trustee oversees the fund.

• Scope: passive schemes only, such as index funds and ETFs.
• Capital: a lower net worth floor than a full AMC, with exact figures in the notified rules.
• Sponsor: either a profit track record or extra capital.
• Other business: restricted without SEBI approval.
• Investor protection: SEBI's rules on disclosure, custody and unit holder rights still apply.

Passive funds are cheaper to run than active ones because there is no research team picking stocks. A fintech with a large user base can attach its own index fund to its app and keep the management fee instead of sending it to another fund house. Brokers, wealth platforms and advice firms see this as a way to earn from assets, not only from trading fees or advice fees.

Passive investing has also grown in India, with more people buying index funds through apps. A lighter licence makes it easier for smaller firms to enter than the full route did. That means more choice for investors, but also more small fund houses that must prove they can run funds reliably.

Wealth platforms and discount brokers are the obvious applicants because they already have users who invest regularly through monthly plans. Advisory firms see a different gain, which is that their own fund can be offered to clients instead of recommending funds from other houses. SEBI keeps an eye on conflicts of interest here, because an adviser recommending its own fund must disclose it clearly.

An AMC charges an annual fee called the total expense ratio, or TER, as a percentage of the money in a fund. SEBI caps this ratio. The fund house pays the costs of running the fund from it, such as the registrar, custody, audit and distribution commission, and keeps what remains.

Passive funds charge low fees, so the business needs a large amount of money under management to be profitable. The sums below are made up for illustration.

Unit holders also pay other charges that are not part of the fund house income, such as brokerage on trades and GST on the management fee. Index funds and ETFs differ from one another in cost and ease of buying. An ETF needs a demat account and trades during market hours, while an index fund can be bought through an app at the end-of-day price. Platforms often offer both.

• Assets under management (AUM): ₹1,000 crore.
• Fee charged to investors: 0.20% a year, so ₹2 crore.
• Running costs, such as staff, technology and compliance: ₹1.4 crore.
• Left for the AMC: ₹0.6 crore a year, before the cost of building the business.

In-principle approval is an early green light, not a licence. The applicant must still meet conditions, such as capital, systems and people, and then receive final registration before it can launch a scheme. After registration, each scheme needs a scheme document and SEBI approval before units are sold.

Stories about an approval therefore describe a stage in a process. A target launch quarter is a plan, not a promise. It can slip if conditions are not met.

After final registration, the AMC needs a trustee company, a custodian that holds the securities, a registrar that keeps the unit records and an auditor. The scheme document explains the index followed, the fee, the risks and how units can be bought and redeemed. SEBI reviews it before units can be sold, so a launch date depends on both the AMC and the regulator.

The first risk is scale. Passive funds earn thin fees, and a new AMC may take years to reach the assets it needs. The second is competition from large existing fund houses and low-cost providers. The third is tracking error, which means the fund's return differs from the index it copies. An investor wants a small, steady gap.

In a headline, check whether the news is a proposal, an in-principle approval or a final registration. Check who the sponsor is, which products are planned and when they are due. Passive funds carry market risk like any other fund. The rules should be read in the current SEBI text, and a professional should be consulted for any specific decision.