Implication of residual investments on core portfolios

1. At a Glance

• Core issue: SEBI now lets equity mutual funds put part of their residual portfolio (the share left over after the mandatory equity allocation) into non-equity assets: gold ETFs, silver ETFs and InvITs. The limit is up to 35% of the residual portfolio [1].
• Why it matters: A "large-cap equity fund" may no longer be pure equity. That changes how an investor's asset allocation across their core portfolio (the long-term holdings meant to fund life goals) actually works out [1].
• UPSC angle: It touches capital-market regulation (SEBI), mutual fund categorisation, investor protection, financial literacy, and the growing role of InvITs in financing infrastructure (GS-III).

2. Why in the News

• The Hindu (Chennai edition, supplement, p. 13, 26 October 2026) analysed SEBI's recent regulation allowing equity funds to invest up to 35% of their residual portfolio in non-equity investments [1].
• The newly allowed instruments are gold ETFs, silver ETFs and Infrastructure Investment Trusts (InvITs) [1].
• The article was written by Venkatesh Bangaruswamy [1].

3. Background & Evolution

• Starting point: Under SEBI's scheme rules, large-cap active funds must invest at least 80% in large-cap stocks [1].
• The residual part: The remaining ≤20% has usually gone into mid-cap and small-cap stocks, mostly mid-caps [1].
• The change: SEBI now also allows gold ETFs, silver ETFs and InvITs in this residual part, up to 35% of the residual portfolio [1].
• SEBI's reasoning: Gold and silver may do well when equity markets fall sharply. Holding them could stabilise fund portfolios in volatile markets [1].
• Not checked this session: the exact circular number and date, and the history of SEBI's scheme-categorisation framework. Check these on sebi.gov.in before relying on them.

4. Core Static Facts

Item	Fact
Regulator	Securities and Exchange Board of India (SEBI) [1]
Who it applies to	Equity mutual funds, e.g. large-cap active funds [1]
Large-cap fund mandate	≥80% in large-cap stocks [1]
Usual residual allocation	≤20%, typically mid-caps [1]
New residual options	Gold ETFs, silver ETFs, InvITs [1]
Cap on non-equity	Up to 35% of the residual portfolio [1]
Mandatory or optional?	Optional. Funds "may or may not" invest in these assets [1]
Stated purpose	Stability in volatile markets, since gold and silver can rise when equities fall [1]

Key terms:

• Core portfolio: long-term holdings built to meet life goals, such as large-cap funds plus bank deposits [1].
• Satellite portfolio: holdings that are traded actively, such as tactical trading in gold or silver ETFs [1].
• Residual portfolio: the part of a fund left after its mandatory category allocation [1].

5. Multi-Dimensional Analysis

Economic / Financial

• Diversification inside the fund: Precious metals can cushion equity drawdowns [1].
• Demand for InvITs: Including InvITs creates a new source of institutional money for infrastructure investment trusts [1].
• Effect on risk and return: Large-cap funds may become less sensitive to equity swings. They may also lag in strong bull markets (analytical inference).

Investor Protection / Governance

• Label vs. content: An investor in an "equity fund" expects equity exposure. Non-equity holdings weaken that expectation [1].
• Double counting: Investors who already hold gold or silver ETFs directly may end up over-exposed to precious metals without realising it [1].
• Disclosure: Because the allocation is optional [1], monthly portfolio disclosures become essential for investors to track their real asset mix (analytical inference).

Behavioural / Financial-literacy

• Rebalancing: Investors using the core/satellite approach need to look at what each fund actually holds, not just its category name [1].
• Fixed asset allocation: An equity-plus-bank-deposit allocation [1] can drift if the equity part quietly holds metals (analytical inference).

Regulatory / Administrative

• Flexibility vs. category purity: The rule gives fund managers room to manage risk, but may reduce true-to-label discipline (analytical inference).
• Optional nature: Different funds within the same category may now behave differently [1].

6. Recent Developments (last 12–18 months)

• SEBI "recently" allowed equity funds to invest up to 35% of the residual portfolio in gold ETFs, silver ETFs and InvITs [1].
• 26 Oct 2026: The Hindu published an analysis of what this means for investors' core portfolios [1].
• Not checked this session: the circular's exact date and the date it takes effect.

7. Prelims Hooks

• Regulator for mutual fund scheme categorisation: SEBI (not RBI, not AMFI) [1].
• Large-cap active funds must hold at least 80% in large-cap stocks [1].
• Large-cap fund residual allocation: up to 20% [1].
• Equity funds may now invest up to 35% of the residual portfolio in non-equity assets [1].
• Permitted non-equity assets: gold ETFs, silver ETFs, InvITs [1].
• InvIT stands for Infrastructure Investment Trust [1].
• The non-equity allocation is optional, not mandatory [1].
• Stated reason: gold and silver may perform well when equity markets decline sharply [1].
• "Core portfolio" means holdings built to achieve life goals [1].
• "Satellite portfolio" can include actively traded gold or silver ETFs [1].

8. Why InvITs Are the Odd One Out in This List

• Gold and silver ETFs are easy to sell. Many InvITs are not.
• An open-ended equity fund must pay back investors who leave on any day. To do that it must sell what it holds.
• SEBI itself has noted that many InvITs do not trade on the stock exchange at all for many days [2].
• In March 2025, Brookfield REIT traded about ₹100 crore a day. Energy Infrastructure Trust, an InvIT, traded about ₹0.27 crore a day. For 8 of the 22 listed InvITs there was no trading figure at all [2].

• So in a market crash, the InvIT part of a fund may be the hardest part to sell. That is the very moment SEBI hopes this part will make the fund steadier [1].

• Most InvITs are sold privately, not to the public

• REITs are listed only through public issues. InvITs can be placed privately or publicly [2].

• In SEBI's March 2025 list, 17 of the 22 InvITs were privately placed, so fewer buyers trade them [2].

• "InvIT" covers very different risks

• AMFI (Association of Mutual Funds in India) told SEBI that some InvITs earn steady annuity payments from government bodies. Others are BOT (Build-Operate-Transfer) toll roads whose income rises and falls with traffic [2].

• So when a fund says it holds an InvIT, that tells an investor little about the actual risk.

• The Finance Ministry raised the same concern

• The Department of Economic Affairs (DEA) told SEBI that REITs and InvITs are less liquid (harder to sell quickly) than shares, and that this must be taken into account [2].

9. Why the Rule Changes Less Than the Headline Suggests

• 35% of the residual is at most 7% of the whole fund
• A large-cap fund's residual part is at most 20% [1]. 35% of 20% is 7%.

• So at least 93% of a large-cap fund can still be equity. The "blurring" worry is real but small in size.

• Equity funds hardly buy InvITs today

• In March 2025, the 35 equity schemes that held REITs or InvITs managed ₹2,63,841 crore in all. Only ₹465 crore of that was in InvITs [2].

• All mutual funds together held ₹5,409 crore in InvITs, against an industry total of about ₹66 lakh crore [2].

• So do not overstate the infrastructure-finance benefit

• The rule is optional [1]. Fund managers already had room to buy InvITs and used very little of it [2].
• A small extra permission inside a 7% slice is unlikely, on its own, to change how India pays for its roads and power lines.
• In a GS-III answer, call it a small, supporting step, not a big financing tool.

10. Why an InvIT Counts as 'Non-Equity' Inside an Equity Fund

• SEBI treats InvITs as 'hybrid', not equity
• Since a SEBI Board decision of January 2017, REITs and InvITs have been treated as hybrid instruments (partly like shares, partly like bonds) when mutual funds invest in them [2].

• SEBI said then that they behave much like shares, but carry risks of concentration (too much money in a few trusts) and liquidity [2].

• In 2025, SEBI proposed splitting the two apart

• A consultation paper of 17 April 2025 asked whether both should be treated as equity [2].
• SEBI's Board memo then proposed treating REITs as equity from 1 January 2026, but keeping InvITs hybrid, because their assets vary widely and they are less liquid [2].

• That is why an InvIT can sit in the non-equity residual part of an equity fund. Check whether the REIT change was finally adopted before you write it as fact.

• The rest of the world treats REITs as equity

• In many countries REITs are counted as equity and included in share indices. Indian REITs are already part of indices such as the MSCI India Small Cap Index and the FTSE India Index [2].

• Existing caps on InvIT holdings

• Before this change, a mutual fund scheme could put at most 10% of its NAV (Net Asset Value, the total value of the fund) into REITs and InvITs. It could put at most 5% into units of any one issuer [2].

11. The Case for Keeping Equity Funds Pure — and Where It Falls Short

• The strongest objection: a core portfolio should be simple and stable
• The investor builds a core portfolio to meet life goals and keeps it mostly unchanged. Trading in gold or silver ETFs belongs in the satellite portfolio [1].
• Buying metals because they "may do well when shares fall" [1] is a market-timing bet. With this rule, that bet now happens inside the core portfolio, chosen by the fund manager and not by the investor.

• An investor who already owns gold ETFs then holds more precious metals than they planned [1].

• What the objection gets right

• Two funds with the same "large-cap" label can now hold different things, because the option is voluntary [1]. A category name is less reliable as a guide.

• Where the objection goes too far

• The non-equity part is at most about 7% of a large-cap fund (35% of a 20% residual) [1]. The fund stays mostly equity.
• Many small investors hold one large-cap fund and nothing else. For them, a small metals cushion inside the fund may be the only diversification they get.

• The money it replaces was going mostly into mid-cap shares [1], which can fall hard in a crash. The swap is not obviously riskier.

• Fair conclusion: the risk is less about the rule being wrong and more about investors not knowing what their fund holds.

12. What Fund Houses, SEBI and Investors Should Do

• Fund houses (AMCs) should say in advance whether they will use the option
• Because the choice is optional [1], an investor cannot tell from the category name whether the fund holds metals or InvITs.

• A clear statement in the Scheme Information Document (the fund's official rulebook), plus the monthly holdings report, would close this gap.

• SEBI should keep the one-issuer cap working inside the residual part

• SEBI's existing rule caps a scheme at 5% of NAV in any one issuer's REIT or InvIT units [2].

• Given how rarely many InvITs trade [2], that cap is what stops one hard-to-sell trust from trapping investors' money during a crash.

• SEBI could follow its own REIT approach: a transition period and a review

• When it proposed moving REITs to equity, SEBI suggested protecting existing debt-fund holdings and letting fund houses sell down slowly [2].

• A similar review of InvIT trading volumes, a year or two after this change, would show whether the liquidity worry came true.

• Investors should count what each fund actually holds, not its label

• Add a fund's gold, silver and InvIT holdings to any metals you hold directly. Then rebalance your core and satellite portfolios [1].

13. Anchors for Answers

• Data: Equity schemes held just ₹465 crore in InvITs, out of ₹2,63,841 crore of assets in the 35 schemes that held REITs or InvITs (March 2025); all mutual funds together held ₹5,409 crore in InvITs, against industry assets of about ₹66 lakh crore [2]
• Data: 17 of 22 listed InvITs were privately placed; 8 had no recorded daily trading volume in March 2025 [2]
• Report/Committee: SEBI Board memorandum on reclassifying REITs and InvITs (September 2025), which followed the 17 April 2025 consultation paper and Mutual Fund Advisory Committee (MFAC) discussions; it proposed REITs as equity and InvITs as hybrid [2]
• Law/Case: SEBI (Mutual Funds) Regulations, 1996; SEBI (REIT) Regulations, 2014 and SEBI (InvIT) Regulations, 2014; REIT and InvIT units count as 'securities' under Section 2(h) of the Securities Contracts (Regulation) Act, 1956 [2]
• Comparison: Many countries classify REITs as equity and include them in share indices; Indian REITs already sit in the MSCI India Small Cap and FTSE India indices [2]
• Scheme: National Monetisation Pipeline, which uses InvITs (e.g. National Highways Infra Trust) as a vehicle to monetise public infrastructure

14. Mains Relevance

• GS-III: Indian Economy, mobilisation of resources, capital markets. Investment models (InvITs for infrastructure).
• GS-II (secondary): Statutory regulatory bodies (SEBI).

Possible questions:

1. "SEBI's decision to allow equity mutual funds to invest in gold, silver ETFs and InvITs blurs the line between asset classes." Critically examine its implications for retail investor protection.
2. Discuss the role of Infrastructure Investment Trusts (InvITs) in financing infrastructure in India. How can greater participation by mutual funds deepen this market?
3. Examine how SEBI balances product flexibility against true-to-label discipline in India's mutual fund industry.

15. Related Topics to Study Next

• SEBI mutual fund scheme categorisation framework: where the 80% large-cap rule and the fund categories come from.
• InvITs and REITs (SEBI regulations): the new permitted asset class and how it finances infrastructure.
• Gold and silver ETFs and Sovereign Gold Bonds: compare ways to hold precious metals.
• Multi-asset allocation funds / hybrid funds: the existing categories that already mix asset classes.
• Asset Monetisation (National Monetisation Pipeline): InvITs are a key vehicle for it.
• Investor protection and financial literacy (SEBI, NCFE): relevant to the risk of mislabelling.
• Household savings shifting to financial assets: the wider context of retail mutual fund growth.

16. NCERT Concepts to Revise

• Mutual fund (Economy): The whole article is about how equity mutual fund portfolios are structured and what they can hold.
• Securities and Exchange Board of India (Polity): SEBI is the regulator that made this rule change and sets fund categories and investor protections.
• Infrastructure Investment Trust (Economy): InvITs are one of the newly permitted non-equity assets; you must know what they are.
• Equity share (Economy): Large-cap funds must hold shares; this explains the equity ownership that the non-equity allocation dilutes.
• Asset monetisation (Economy): InvITs are a key vehicle for monetising public infrastructure assets, linking this rule to infrastructure financing.
• Capital market (Economy): Mutual funds, ETFs and InvITs all operate in the capital market that SEBI regulates.

17. Common Errors / Trap Areas

• 35% is not 35% of the whole fund. It is up to 35% of the residual portfolio [1].
• Wrong regulator: It is SEBI, not RBI or AMFI [1].
• Optional, not mandatory: Funds may invest in these assets; they are not required to [1].
• InvITs ≠ REITs: The article names InvITs only [1]. Do not assume REITs are included without checking the circular.
• Large-cap minimum: It is 80% [1], not 65%. The 65% figure applies to other equity definitions, e.g. for tax purposes (not checked this session).