According to industry sources, the proposed ban may initially apply only to regional and thematic passive schemes. Another major category within passive investing – smart-beta funds – may face limits on the number of schemes that can be launched by an asset management company (AMC).

“These are some of the suggestions given by the industry. However, the regulator may choose a different approach,” said a senior mutual fund official.

Queries sent to SEBI and Association of Mutual Funds in India (AMFI) remained unanswered at the time of publication.

Earlier this year, Sebi had introduced a 50 per cent overlap rule for active sectoral and thematic funds to prevent the launch of almost identical products. According to another industry executive, the regulator is exploring similar guardrails for the passive segment and has sought feedback from Amfi.

Over the past few years, new fund launches have increasingly focused on the passive space as asset managers have sought to capture market share in the rapidly expanding segment. The absence of launch restrictions, with greater scope for product innovation, has led to a rapid increase in the number of offerings.

The number of passive schemes, including foreign products, has increased fivefold in the last six years. At 740, the share of passive schemes among all MF schemes is about 40 per cent, whereas it was only 8 per cent in April 2020.

There has been an increase in launches along with strong interest from investors. Assets under management (AUM) in passive products, including gold and silver ETFs and foreign funds-of-funds, have grown nine-fold since the pandemic to nearly ~₹15 trillion.

The proliferation of mutual fund schemes first came under Sebi’s scrutiny in 2024, when fund launches hit a record high amid a strong equity market rally. More than 50 regional and thematic funds were launched that year and around 130 passive funds were launched.

Regulatory concerns were heightened by the concentration of launches in relatively narrow and high-risk categories such as thematic and smart-beta funds, which were also attracting significant investor inflows.

New fund offers (NFOs) generally attract investor interest during bull markets, with fund houses often launching products linked to sectors, themes or factors that have already delivered strong returns. This increases the risk for investors of entering at or near the peak of the cycle and subsequently experiencing poor performance.