Provident funds may not be allowed to invest over 5 per cent of the net assets under their management in a mutual fund.

The guidelines, to be issued by the labour ministry soon, will allow provident funds to diversify their investment avenues as permitted by the finance ministry.

Ministry sources said the 5 per cent limit would ensure that a fall in the net asset value of a mutual fund would not adversely affect the health of a provident fund.

Besides giving the green signal for investments in mutual funds, the finance ministry has allowed the percentage of residual investment permitted to provident funds to be raised from 20 per cent to 30 per cent.

The new guidelines are part of the government's measures to prop up provident funds' earnings, which have been declining after the Centre's Special Deposit Scheme was closed in the previous fiscal.

The finance ministry had, however, not set any specific limit for investment in mutual funds by provident funds.

Government sources said the residual investment norms were likely to be stringent and would prevent a repeat of the events that led to the switching of funds from debt to equity by some mutual funds.

Provident funds at present report their investment patterns to the Regional Provident Fund Commissioner every month. The commissioner, in turn, prepares a consolidated report for the headquarters of the Employees Provident Fund Organisation.

Accordingly, the EPFO will have to await the report of the Regional Provident Fund Commissioner at Kanpur about the alleged switching of investments of nearly Rs 2 crore (Rs 20 million) of a Kanpur-based provident fund by the Kanpur office of ICICI Prudential before deciding on a course of action.

Transparency in investment norms is expected to reduce the chances of recurrence of such events.