“True to label”: the 80% equity floor and the overlap caps

What changed

SEBI issued a circular on the categorisation and rationalisation of mutual fund schemes on 26 February 2026. It replaced the earlier categorisation guidelines, with the stated aim of reducing duplication between schemes and keeping funds true to their labels.

Two provisions matter most to an ordinary investor. The minimum equity exposure for several equity categories was raised from 65% to 80%. And portfolio overlap was capped: sectoral and thematic funds must limit overlap to 50%, and value and contra funds are permitted with a maximum 50% overlap.

Equity funds were also permitted to invest the residual portion of the portfolio in a wider set of instruments, within the ceilings applicable to each asset class.

Why it matters

The problem being solved is a real one. If you deliberately bought a thematic fund for exposure to a specific theme, and the portfolio in practice looked much like a diversified fund, you did not get the exposure you chose — while typically paying for an actively managed specialist mandate.

The same logic applies in reverse to diversification. An investor holding four equity funds believing they are diversified across styles is not diversified if the underlying stocks are largely the same. Overlap caps make that failure mode less likely by construction, rather than leaving it to the investor to detect.

Raising the equity floor from 65% to 80% works in the same direction: a category described as an equity category must actually be substantially invested in equity, not sitting in cash or non-equity instruments while carrying an equity label.

How overlap is measured

Overlap between two schemes is calculated using the lower weight of each stock common to both portfolios. If a stock is 8% of one fund and 5% of the other, it contributes 5 percentage points to the overlap. Adding those contributions across all common holdings gives the overlap figure.

A total above the permitted 50% means the fund manager must reduce common holdings to comply. Existing sectoral and thematic schemes have been given a three-year window to align their portfolios, so this is a transition rather than an overnight change.

The “residual portion” — a smaller change than it sounds

Under the new rules an equity fund may invest its residual portion — what remains after the mandated equity allocation — in instruments including gold, silver, InvITs and money market and other liquid instruments, subject to the ceilings SEBI applies to each asset class.

Previously fund managers largely held cash in that residual space. The change gives some additional flexibility. It does not turn an equity fund into a multi-asset fund: the mandated equity floor, now higher for several categories, still governs the bulk of the portfolio.

What to check

1. Whether any AMC notice has told you a scheme you hold is being realigned to the new category definitions.
2. If you hold several equity funds, whether they genuinely occupy different mandates now that the definitions are tighter.
3. The scheme factsheet for the stated category and the actual allocation, which should agree more closely than they once did.
4. For a thematic or sectoral holding, whether the theme you bought is still the theme the portfolio expresses.

Frequently asked questions