What Is the 75-5-10 Rule for Mutual Funds

75-5-10 rule requires that a fund's assets are invested, 75% of its assets in other issuers and cash, no more than 5% of assets in any one company, and no more than 10% ownership of any company's outstanding voting stock.
What is the 75-5-10 rule for mutual funds
3 min
05-July-2024

The 75-5-10 rule for mutual funds is an investment guideline for diversified mutual funds. Under this rule, such funds must invest 75% of their assets in other issuers’ securities and cash, not more than 5% in any one company, and not more than 10% in holding the issuers’ outstanding voting shares.

Mutual funds have become one of the most sought-after investment instruments. They are comparatively less volatile and managed by expert portfolio managers. Investors look toward investing in mutual funds to multiply their investments through compounding and diversifying them.

Investors who seek diversification by investing in mutual funds should ensure that the scheme is launched by a diversified management investment company. For that purpose, the mutual fund house must have assets that adhere to the 75-5-10 rule.

This blog will help you understand what is the 75-5-10 rule for a mutual fund to ensure that you can identify diversified mutual fund schemes for effective diversification.

What is the 75-5-10 rule for mutual funds?

An investment company, such as a mutual fund house, pools money from various investors to invest in a host of securities, such as equities and bonds. Since a mutual fund house holds a portfolio of assets, investors invest in a specific mutual fund scheme to ensure their portfolio is diversified and they can spread the risk across various investment instruments.

In the case of a mutual fund house, the company is known as diversified only if it follows the 75-5-10 rule. The rule is as follows:

  • 75% - 75% of the fund assets must be invested in other securities such as equities or cash and cash equivalents such as Treasury bills.
  • 5% - The company must not invest more than 5% of its assets in any one company.
  • 10% - The mutual fund company must not invest more than 10% of its assets in holding any company’s outstanding voting stock.

A mutual fund house must have the above asset allocation structure to be called a diversified fund house. If it fails to allocate its assets in this order, it ceases to be termed diversified, increasing the attached risk.

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How to use the 75-5-10 rule for mutual funds?

The 75-5-10 rule for mutual funds allows you to identify diversified mutual fund schemes with a balanced portfolio and can offer steady and low-risk returns. Here is how you can use the 75-5-10 rule for a better investment approach in mutual fund schemes.

  • The 75%: The mutual fund house must invest 75% of its total assets in securities of other companies and cash and cash equivalents. These investments are mostly in top holdings, along with cash and cash equivalents that have lower associated risks. This ensures that the majority of the fund's investments are in stable and well-performing assets, increasing returns while taking on lower risks.
  • The 5%: The mutual fund house must not invest more than 5% of its assets in a single company's stock. It means that the fund will invest in various stocks, spreading the risk of losses if one investment falls in price while preventing overexposure to the performance of one company.
  • The 10%: The fund house must not invest more than 10% of the assets in any company’s outstanding voting stock. This allows protection from risks attached to investing in a single company’s outstanding voting stocks, as investors with voting rights can influence a company’s operations positively or negatively.

Examples of using 75-5-10 rule

For a better understanding of using the 75-5-10 rules for mutual funds, here is an example of how a mutual fund allocation should look that follows the rule:

Mutual Fund A

Total assets: Rs. 100 crores

  • 75% top holdings: Top 5 holdings sum up to Rs. 60 crores (60%).
  • 5% single stock: Largest holding, company X, at Rs. 4 crores (4%).
  • 10% outstanding voting stocks: Company P’s outstanding voting stocks, at Rs. 18 crores (9%).

As you can see from the above example, this fund successfully applies the 75-5-10 rule for mutual funds, maintaining diversification and effectively managing risk.

Also read about: What is a risk profile

Benefits of using the 75-5-10 rule for investors

Here are the benefits of using the 75-5-10 rule for investors:

Effective diversification

Choosing mutual funds schemes that follow the 75-5-10 rule provides enhanced diversification, as the investments are not limited to a single security but multiple securities across various asset classes. This significantly reduces the risk of losses from any single investment.

Risk management

Investor investing in diversified mutual fund schemes allows for a balanced investment approach that includes a mix of high-quality assets. The rule helps in achieving long-term growth and stability, as different sectors and stocks perform well at different times, thus promoting effective risk management.

Transparency

Mutual funds that follow the 75-5-10 rule provide a transparent structure where investors know how the assets are allocated. Investors can be more confident that their investments in mutual fund schemes are managed in a way that minimises risk and promotes steady growth.

Liquidity

Diversified mutual funds are more liquid than other types of mutual funds as they attract more risk-averse investors. Hence, investors who invest in diversified mutual funds are more likely to find buyers quickly, making it easier to realise cash for their investments.

How to choose mutual funds using the 75-5-10 rule?

Here is how you can choose mutual funds using the 75-5-10 rule:

1. Understand the 75-5-10 rule

Before making a mutual fund investment decision, understand what is the 75-5-10 rule for a mutual fund in detail. It will allow you to decide whether the rule is apt for you or if you want to create your own mutual fund investment strategy.

2. Identify your investment goals

Review your current financial situation to determine how much you can invest in mutual funds, either as a lump sum or through monthly SIPs. Furthermore, identify how long you want to hold your investments and for what purposes (short-term or long-term goals). This will help you identify your investment goals, risk appetite, and investment horizon.

3. Compare mutual funds

Compare mutual funds trading on stock exchanges to identify those following the diversified 75-5-10 asset allocation structure before investing. You can do this by analysing the prospectus of mutual funds and reviewing the fund’s portfolio, including top holdings, sector allocation, and individual stock investments.

Challenges of the 75-5-10 rule

Here are the challenges you may face if you invest in mutual funds that follow the 75-5-10 rule:

Limited flexibility

When fund managers use the 75-5-10 rule for mutual funds, they have limited flexibility to reap the benefits of good investments. For example, suppose a fund manager thinks that a single stock is fundamentally and technically strong and can offer hefty returns. In that case, the rule does not allow more than 5% of the fund’s assets to be invested in a single stock. This lack of flexibility can force the mutual fund to lose out on higher profits.

Lack of real-time adjustment

The capital market is volatile and can change quickly. The rule’s rigid adherence to predetermined asset allocation may prevent fund managers from responding quickly and effectively to change the asset allocation to avoid potential losses.

Performance impact

Diversification based on set asset allocation limits the potential for higher gains. In a bullish market, this rule might prevent the fund from achieving maximum returns. Furthermore, the rule may force fund managers to include low-quality stocks to meet the asset allocation requirements.

Lower returns

Investing in mutual funds that follow the 75-5-10 rule can provide a low-risk investment option but come with the possibility of offering lower returns than other mutual funds that invest majorly in equities. Furthermore, the rigid asset allocation structure may offer lower overall returns if other investments turn negative.

Factors to consider while using the 75-5-10 rule

Here are the factors you should consider while using the 75-5-10 rule:

  • Risk tolerance: Assess your risk tolerance to determine whether your portfolio needs a diversified mutual fund.
  • Demat account: Consider opening a demat account with a reputed stockbroker to invest in mutual fund units.
  • Fund performance: When comparing diversified mutual funds, evaluate them on historical performance, consistency, and track record of delivering returns over the long term.
  • Asset allocation: Ensure that the mutual fund you are investing in adheres to the asset allocation specified in the 75-5-10 rule.
  • Liquidity: Ensure that the selected funds offer sufficient liquidity, allowing for ease of entry and exit from investments as per your financial needs and market conditions.

Conclusion

The 75-5-10 rule for mutual funds is a specified rule where the fund house follows a predetermined investment approach. The rule allows a mutual fund scheme to be called diversified and offers low-risk investment options with the potential of steady returns. Now that you know what is the 75-5-10 rule for mutual funds, you can make informed decisions while investing in mutual funds schemes.

You can visit the Bajaj Finserv Platform to use unique tools such as mutual fund calculators to compare mutual fund schemes and invest in the most diversified and suitable ones.

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Frequently asked questions

What is the 75-5-10 rule in mutual funds?
The 75-5-10 rule states that mutual funds must invest 75% of the fund’s assets in other issuers’ securities and cash, not more than 5% in any one company, and not more than 10% in holding the issuers’ outstanding voting shares.
Why is the 75-5-10 rule important for mutual funds?
The 75-5-10 rule is important for mutual funds as it results in healthy diversification and provides low-risk, steady returns to investors.
How does the 75-5-10 rule promote diversification?
The 75-5-10 rule promotes diversification by setting pre-determined asset allocation limits of 75%, 5%, and 10%. It means that investments are spread across numerous assets and provide effective diversification.
What types of assets are included in the 75% portion of the rule?
The 75% portion of the 75-5-10 rule typically includes assets such as equity mutual funds, individual stocks, or exchange-traded funds (ETFs) that offer exposure to the stock market.

Can a mutual fund still be considered diversified if it does not adhere to the 75-5-10 rule?
No, a mutual fund must adhere to the 75-5-10 rule for mutual funds to be called a diversified mutual fund.
What happens if a diversified mutual fund exceeds the 5% or 10% limitations?
If a diversified mutual fund exceeds the 5% or 10% limitations set by the 75-5-10 rule, it may indicate a shift from the desired asset allocation. In such a case, investors must consider portfolio rebalancing.
Are there any exceptions to the 75-5-10 rule?
The 75-5-10 rule may have some exceptions based on investor risk profiles, market conditions, and specific investment opportunities. However, after such changes, the mutual fund ceases to be termed diversified.
How does the 75-5-10 rule affect mutual fund management?
The 75-5-10 rule influences mutual fund management by guiding their asset allocation decisions as they have to adhere to a specific asset allocation limit.
Does the 75-5-10 rule apply to all mutual funds?
The 75-5-10 rule is a general asset allocation guideline and does not universally apply to all mutual funds. If a mutual fund wants to be termed as diversified, it can use the asset allocation rule.
What are the benefits of investing in a mutual fund that follows the 75-5-10 rule?

The biggest benefit is effective diversification, which can significantly lower the risk and ensure steady long-term returns.

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