However, experts have cautioned about potential risks related to liquidity, taxation, and regulatory compliance.
In a consultation paper released on 17 April, Sebi proposed increasing the single issuer investment limit for equity schemes from 5% to 10% of net asset value (NAV) and raising the overall investment limit in REITs and InvITs for equity and hybrid schemes from 10% to 20%.
The existing 10% limit for debt schemes will remain unchanged. The regulator anticipates that this will channel greater capital inflow into these instruments, thereby broadening their market base and improving liquidity.
REITs and InvITs
REITs pool capital from numerous investors who purchase units in the trust, which is then used to invest in a portfolio of real estate properties. The income generated from these properties (primarily through rent) is then distributed to the unit holders as dividends.
Similar to REITs, InvITs pool money from investors to invest in a portfolio of infrastructure assets. The income generated from these projects (for instance, toll collections, power tariffs) is then distributed to the unit holders.
Experts have noted that while Sebi’s proposal could enhance liquidity and growth in real estate and infrastructure sectors, clearer disclosures and potential reclassification to align with global norms are necessary to ensure investor protection.
Anand K. Rathi, co-founder of MIRA Money, believes that increasing the allocation of equity mutual funds could offer fund managers a wider array of investment options, as these instruments provide regular income through dividends and returns that can act as a hedge against inflation. “If REITs and InvITs are classified as equity instruments, they will become more accessible and attractive for indices. This change could stimulate demand and increase market activity around them, similar to how REITs are treated in countries like the US,” he stated.
Debate on classification
While some experts support classifying REITs and InvITs as equity instruments to align with global norms and improve mutual fund risk profiles, others caution that their hybrid nature and regulatory limits could complicate fund classification and tax treatment.
Kunal Sharma, partner at law firm Singhania & Co, suggested that given the recent regulatory changes aimed at aligning with international standards, Sebi might strongly consider the globally prevalent practice of classifying REITs and InvITs as equity instruments. “The regular inflow from such investments may improve the overall risk profile of mutual fund schemes,” he said.
However, some experts, while acknowledging the benefits, disagreed with fully classifying REITs and InvITs as “equity” instruments. “It need not be classified as equity, but rather as hybrid since it has characteristics of both fixed income as well as equities,” opined Raj Mehta, fund manager at PPFAS Mutual Fund. Mehta also suggested that a change in classification might not immediately lead to increased trading volumes or liquidity for REITs or InvITs.
Nevertheless, Mehta added that if Sebi’s proposal to classify these securities as ‘equity’ and their subsequent inclusion in equity indices is implemented, “it might give flexibility to invest in these securities instead of pure equity and it would help reduce the inherent risk in the portfolio.”
Compliance and risk factors
Meanwhile, Ashok Sathyanathan, founder of LexAashraya, emphasized the regulatory classification issue, explaining that substantial mutual fund investment in REITs/InvITs could lead to a loss of classification as an equity or debt fund—impacting tax treatment, investor eligibility, and fund strategy and perception.
Sebi’s mutual fund regulations stipulate that different types of funds must maintain specific investment thresholds: debt funds must invest at least 80% in “debt securities,” while equity funds must invest at least 65% in “equity instruments.”
Since REITs and InvITs are not classified as debt, they do not stick to the 80% debt investment requirement—limiting debt funds to a maximum of 10% of their NAV in REITs/InvITs, with a 5% cap on single-issuer exposure. Similarly, as REITs and InvITs do not count towards the 65% equity requirement, excessive investment by an equity fund could jeopardize its “equity fund” classification, leading to tax and regulatory implications.
“Tax treatment also diverges from pure equity or debt. Units of REITs/InvITs are taxed like non-equity instruments, unless they meet certain listing and holding requirements. This affects mutual funds’ after-tax returns and suitability in tax-sensitive portfolios,” Sathyanathan explained.
Transparency, education key
Experts also highlighted the generally limited liquidity within the REITs and InvITs space. “These instruments are still relatively niche in India, which means their pricing and valuation metrics may not always be as stable or transparent as those of traditional equities. Many mutual fund investors may not fully understand how REITs and InvITs function. Therefore, education and transparency are essential,” Rathi noted.
Legal experts pointed out that allowing greater mutual fund investment in REITs and InvITs would introduce significant complexity and responsibility for asset management companies (AMCs), even if these instruments are categorized as “hybrid” rather than fully as equity.
“Disclosure of risks specific to these instruments, such as liquidity risk, sector concentration, and regulatory changes, will be critical for investor awareness. AMCs will likely have to revisit investor suitability norms and risk profiling processes, as increased exposure to REITs and InvITs may alter the risk-return profile of schemes,” Sathyanathan said.
