If you have been looking to diversify into non-equity assets through the mutual fund route, here's one more alternative that's going to be available soon. The Securities and Exchange Board of India (SEBI) has been pondering on allowing mutual fund houses to invest in Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs). The capital market regulator believes such investments by mutual funds can be classified as ‘alternative securities’.  The SEBI board is likely to discuss this proposal during the board meeting scheduled on January 14, 2017, in Jaipur.

What will change for mutual funds?

If the proposal is accepted without any modification, then mutual fund houses can invest upto 10% of their total Assets Under Management (AUM) in a single project. And 5% will be a single project limit per scheme. Furthermore, no scheme can invest more than 10% of its assets in alternative securities.

Additional compliance for existing schemes

All existing schemes will have to ensure that, in case they plan to invest in alternative securities, there shouldn't be any change in the fundamental attributes of the scheme. As per SEBI, the fundamental attributes can be of 3 types...
 

• Scheme Type: Open-ended, close-ended, interval etc. The Schemes can be further classified into sectoral funds, equity funds, balanced funds, income funds, and index funds among others.
• Investment Objectives: Capital appreciation/income generation/both. Asset allocation is another important consideration.
• Terms of Issue:  Liquidity and redemption provisions, expense structure, safety nets and guarantee provided, if any.

In other words, all existing schemes will have to ensure that there shouldn't be any change in any of the above attributes on account of it investing in alternative securities such as REITs and InvIts.

Will investors benefit from of this move?

From the diversification point of view, allowing mutual fund schemes to invest in REITs and InvIts would be a welcome development, as and when it happens. It's likely that the first listing of InvIt may happen towards the end of this Financial Year (FY) or thereabout.

There are few things that mutual fund investors must understand...
 

• The mutual funds are not going to invest in projects directly. They are going to invest in InvIts and REITs which will be Trusts already established and listed. So for mutual fund investors, exposure to REITs and InvITs would be indirect, just as when one gets exposure to equity assets by investing in a fund of funds.
   
• Unlike equity, REITs and InvIts are construed more as stable income assets, as the exposure of investors, in a large part, is to complete income generating projects. Rents earned on finished infrastructure and real estate projects get distributed among investors of REITs and InvIts.
   
• Therefore for mutual fund schemes investing in such alternative securities, it would be crucial to decide, at what valuations they are picking up stake in REITs and InvIts. What's the current and expected yield and how these yields are moving vis-à-vis benchmarks. Mutual funds would earn through dividends distributed by REITs and InvIts.
   
• Being a new product, there is no established benchmark for comparing yields of REITs and InvIts. However, the yields on sovereign bonds of various maturities may become a good starting point to gauge the attractiveness of the rentals.
   
• These products will open a new investment avenue for mutual funds, especially at a time when interest rates in India are falling. Under such a scenario finding out high-yielding bonds of good credit quality has become increasingly difficult.
   
• Any decrease in rent yields and property valuation may pose a challenge for REITs and InvIts. As against that, smooth functioning and fair valuations would gather a lot of investor appetite for such products.

SEBI has cautiously proposed for mutual fund schemes to be permitted to invest a small component of their portfolio in REITs and InvIts. Liquidity remains a challenge in the secondary market for REITs and InvIts. SEBI has taken a calculated risk of exposing retail investors to this market in an attempt of improving the market participation in such products.

In western countries where bond yields have remained negative for the last 7-8 years, REITs and InvIts have done relatively well. It remains to be seen how they perform in India. An upside is, there is no ambiguity on regulatory framework at this point in time.

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