Dematerialization of Mutual Fund Units – Simplifying the Investment Process

For quite few months, Mutual Funds in India have witnessed investors’ friendly regulatory changes, thanks to SEBI.  Right from the ban of entry loads in Aug 2009 to facilitating transactions in mutual funds schemes through the existing stock exchanges infrastructure in Nov 2009, SEBI now allowed mutual fund investments to be held in dematerialized form. It means that investors will have the option to convert their existing mutual fund investments into dematerialized form and buy/sell units through stock exchanges.

Background

With the removal of entry loads, SEBI intends to bring an advisory model where the intermediary charges a fee directly to the investors for providing advisory services to them. This reduced distribution incentive for distributors who found difficult to serve customers in far-flung areas or tier-3 & 4 cities. With this intent to provide mutual fund services to every nook and corner of India, SEBI decided to utilize the existing stock exchange infrastructure for mutual fund transactions.

Dematerialization of Mutual Fund Units

1.       Process

·        If you are an existing demat account holder, you can submit a Conversion Request Form (CRF) from your DP and submit the fully filled CRF form along with the Statement of Account to your DP. After due verification, the DPs will co-ordinate with the Asset Management Companies (AMC) and their Registrar and Transfer Agents which in turn after due verification
will credit the mutual fund units to your demat account.

·        If you are not a demat account holder, you will require to open a demat account with a DP before you can convert existing mutual fund units in demat form.

2.       Subscription of Units

Investors can subscribe to Mutual Fund units through their Stock Broker using the Stock Exchange platform. Upon subscription, the AMC/RTA will credit the mutual fund units to your demat account.

3.       Redemption of Units

Investors can redeem their dematerialized mutual fund units through two different modes. They can submit Redemption Request Form which in turn will send to the AMC/RTA after due
verification. The AMC/RTA will verify the form and credit the maturity proceeds in the bank account available in the depository system.

Why should you convert Mutual Funds into demat form?

1.      Consolidation – Even you are holding mutual funds investments with a number of AMCs, say 10 or 20, you can view all the transactions in a single statement instead of managing and collection statement of accounts from all AMCs.

2.      Easy Monitoring – Once you have your holdings at one place, you will be able to monitor them effectively and can also analyze its performance in one go.

3.      Fast transactions – Having all Mutual Fund units in a demat account can allow you to buy/sell the units without any inconvenience. It can be done either through a phone call or an online instruction unlike in physical units where you need to sign the repurchase form with each
AMCs and submit it in their point of presence (PoPs).

Drawbacks

The holding of MF units in demat account will necessarily lead an additional cost, a cost charged by stock broker on maintaining the demat account along with transaction charges. Currently, all brokers are offering transactions on MF units at free of cost which they might abandon once the volume picks up.

The impact will be minimal for those who already have a demat account with DPs. The potential of dematerialization of mutual fund units nullifies the cost associated with the demat account. Once powered with the demat units, the convenience and ease of transactions will definitely overrule the process of managing transactions with different AMCs. It provides a single platform to transact across multiple fund houses and their associated schemes. This is one of simplified steps which will help in simplifying investors’ financial life. Moreover, dematerialization of mutual fund units will improve the documentation process.

The glitter of Gold – its unprecedented hike

Old is Gold – the Gold shines more than its spark. In the current global financial breakdown, Gold emerged as the safest asset and its price headed northwards reaching a record $ 1,431.25 an ounce on Dec 07, 2010, the longest Bull Run in at least 90 years. What led to the unprecedented hike in its prices? India and China hoard a major portion of gold outputs in the world.

In the 19^th century, the Gold Standard took place and lasted until the First World War. It was partially reestablished during the interwar period. The Great Depression of the 1930s brought the gold standard to a final end.

In that era, the world subscribed to the Gold Standard which implied specific rules for the system of international payments. International payments lead to gold transfers between countries. Banque De France explains in its Focus (authored by Gong Cheng, Laurent Ferrara, Yannick K and Pascal T)

When a country runs a balance of payments deficit (surplus), it has to make (receive) a payment in gold. Domestic gold holdings decrease (increase) and domestic money supply contracts (expands). Domestic money supply is thus determined by the balance of payments. This provides an adjustment mechanism to external imbalances. Suppose for instance that a country runs a trade deficit. This leads to a decrease in gold holdings and a monetary contraction. This contraction generates a decrease in domestic prices. With lower relative prices, the country becomes more competitive and its current account is brought back to balance. This adjustment mechanism was described by David Hume in his famous 1752 essay.

The more can be read here…

However, the Gold Standard met its ending with the major economies moving away and after the Second World War, the Bretton Woods system replaced the gold standard. Instead of a gold parity, countries announced a fixed but adjustable parity to the dollar, which in turn was initially fully convertible into gold.

While there were many advantages but it got several drawbacks, which would probably turn out to be very dangerous and a source of instability for the world economy.

What led to Gold roaring a high of $ 1,431.25?

No doubt the financial crisis prompted investors in lapping up gold in big denominations; the back end analysis shows that the assets soared of Gold ETFs accumulating the major portion of world gold output. Globally, the 10 biggest such funds now hold a combined 2,113 metric tons of gold, more than the official reserves accumulated by every country in the world save four: the U.S., Germany, Italy and France. India and China hoard of major portion of gold outputs. Recently, the Central Bank of India, RBI bought a major portion of gold which also helped in showing investors’ interest in gold.

The story goes as below:

James Burton, the then Chief Executive Officer of California Public Employees’ Retirement System (CALIPERS) didn’t invest a penny in Gold of the total assets of $ 142.8 billion managed in 2002. The quiet obvious reason – the yellow metal had been in a bear market for two decades.

Christopher Thompson, the Chairman, World Gold Council convinced him to help in allowing investors to buy a previous metal they had shunned for generation. The key was dividing bars of gold into securities tradable on the New York Stock Exchange. And thus, the SPDR Gold Trust got its way and found the cheapest way of holding gold which now holds around 1,299 metric tons of gold valued at $ 57 billion, more than Swiss central bank. Their popularity (number of other Gold ETFs) helped driving unprecedented gains for the precious metal which can go even higher, as per analysts.

Read more on the parabolic rise of Gold.

Should we continue subscribing to it?

Gold’s worth is determined by fears of inflation or financial collapse. Unlike other eatable assets which are determined based on economic factors, gold’s true value is hard to judge for retail investors. In India, the demand will be factored by its sparkle coupled with the ETF demand.

Happy Reading!

Amar Ranu

Corporate Bond Markets - Robust Credit Cultures a Key to Development

Post the recent global economic crisis, there has been a significant shift in powers from developed nations to emerging market economies (EMEs). The sovereign crisis of European Countries, famously called as PIIGS (Portugal, Ireland, Italy, Greece and Spain) have questioned the dominance of emerging nations. In order to boost the economy growth, several developed nations have pledged to keep their interest rates at or near zero for an elongated period. The sovereign ratings of PIIGS have been cut and their fiscal deficits have reached to a record high.

The Asian story depicts a different perspective; the strong domestic consumption especially in India and China has led to the rally in the economy which has forced the central banks and governments to roll back their accommodative measures to tame the inflation. Out of these issues, it remains an important question how developed our bond markets – government bonds and corporate bonds are and it helps in measuring the pulse of the economy.

While the Asia-Pacific countries have made a good progress in developing local corporate bond market, they have a long way to go ahead. In India, Government Securities market are fairly developed on account of large quantum of government borrowings which have led to active trading and price discovery in securities of all tenures. However, in corporate bond market, we have a long way to go.

M. T. Raju, Upasana Bhutani and Anubhuti Sahay (2004) in their working paper “Corporate Debt Market in India – Key Issues and Policy Recommendations” have rightly pointed out for the need of “Single Trading Platform” instead of different platforms operated under NSE, BSE and FIMMDA. It tells that the different platforms allow liquidity bifurcated. They also emphasized the need of repo market in corporate debt. Recently, the RBI allowed the repo trading in corporate bond which might provide the liquidity in corporate bonds.

In another commentary report by Standard & Poors – “Fostering Robust Credit Cultures Is Key to Developing Deep and Liquid Corporate Bond Markets in Asia-Pacific”, Thomas G Schiller rightly pointed out that many Asia-Pacific seek to build market maturity and sophistication so as to attract many issuers to their countries. They have been emphasizing on robust credit cultures which are built on key elements such as transparency, independent and objective credit analysis, risk-based pricing, creditors’ rights and arm’s length relationships. In his commentary, he explained about the growing and maturing corporate bond markets in Australia, Hong Kong, Japan, Korea, Malaysia, New Zealand, Singapore, and Taiwan, and emerging markets in China, India and Thailand. About India, he mentions that India is a mostly sound credit culture that is still improving in some areas such as creditors’ rights. India’s corporate bond market is small but growing rapidly. Issuance grew by about 60 per cent over the two years to end-financial year March 31, 2010. However, the recent regulatory developments are enabling bond market development, including: the easing of issuance and listing requirements; the enhancement of disclosure requirements for issuers; the clearing of bonds through stock exchanges; and the introduction of credit default swaps (CDS) and interest rate swaps. He concluded that the process of building capital markets in banking dominated environment is a long and laborious one because it involves changing of a country’s business culture.

Read more about other countries here.
Happing Reading!

- Amar Ranu

(Permission sought from S&P to post their articles on this blog)

Equity Outflows dampened; Net assets grew to Rs. 6.65 lakh crore

In 2010 YTD, FIIs have been pouring money (referred as ‘hot money’) following the continuing global economic turbulence all over and thus, in some aspects, the inflows have been providing a temporary relief to burgeoning Current Account Deficits (CAD), expected to be over 3 per cent in current Fiscal Year. On the contrary, Mutual Funds have been bleeding seeing their assets depleting rapidly, especially Equity outflows. However, in Nov 2010, the situation improved in favour of domestic Mutual Fund Industry. On an average, the total industry AUM increased to Rs. 6.65 lakh crore, up by 2.92 per cent. Since the last four months, assets had been depleting continuously. The maximum growth was seen in Liquid/Money Market where the assets grew to Rs. 99,190 crore, a growth of 15.37 per cent over the last month.

Gilt Funds, where the investments are predominantly in Government Securities have seen an increased activity where a lot of investments flew in. The AUM grew to Rs. 4,410 crore, an increase of 11.08 per cent while the total inflows were Rs. 431 crore. This is the only category which has been witnessing positive inflows for the last 6 months. The high gilt yields scenario is throwing an opportunity for investors to reap the capital gains once the yields come down on account of eased liquidity situation, low inflation and improved economic outlook.

In Equity, the outflows continued albeit at much lesser amount. In Nov 2010, it saw an outflow of Rs. 41 crore only in comparison to an average outflow of Rs. 3,523 crore in last five months. The ELSS category too continued with the net outflow. This month, the outflow had been to Rs. 62 crore. In last eight months, the category saw the redemption of Rs. 993 crore, the maximum in recent years. However, the Balanced Fund category which involves a mix of Equity and Debt investments saw an inflow to the amount of Rs. 255 crore. However, its AUM declined to Rs. 18,871 crore in Nov 2010 from Rs. 19,462 crore in Oct 2010.

ETFs continue to move unidirectional with inflows. The Gold ETFs have drawn an added interest from investors which led to an inflow of Rs. 172 crore. In last 19 months, the category witnessed positive inflows in 18 months, the maximum among all categories. In other ETFs section, the inflows continued with a major addition of Rs. 328 crore. The AUM also rose to Rs. 1,852 crore in Nov 2010 from Rs. 1,690 crore a month earlier.

In Income category, the total AUM increased by 3.99 per cent to Rs. 3.31 lakh crore. The category saw an inflow of Rs. 11,307 crore in Nov 2010.

There were no new funds launched in Equity category; however, there was an open ended Gold ETF (Axis Gold ETF Fund) and Fund of Funds investing Overseas (JP Morgan EEMA Equity Offshore Fund) launched in Nov. However, there was a flurry of Fixed Maturity Plans (FMPs). A total of 36 FMPs was launched in Nov 2010 collecting a total fund of Rs. 5,281 crore. The liquidity deficit has sent the short term yields higher which have helped the Fund Managers to lock in the opportunity in dolling out FMPs which provide tax benefits in comparison to other investment products.

Source: MOSL

Happy Reading!

Policy Tools post Global Financial Crisis – US Perspective

Since 2008, the world economy is in bad shape! Post the Lehman fall in Wall Street in 2008, the contagion effect ran scathe through the entire global economy. The governments in conjugation with their respective Central Banks announced a series of monetary and fiscal policies which helped in containing the reversal in growth and boost the economy. Also many countries announced bail out programs for many of its big institutions who had over leveraged themselves and became a victim of sub-prime crisis.

It is largely considered that the world biggest economy, United States defines the path of the market and the world market swings around it. Since the financial crisis that emerged in summer of 2007, the Federal Reserve used various liquidity and credit programs and other monetary policy tools. These tools aimed at addressing severe liquidity strains in key financial markets, cultivating faster economic recovery by lowering the longer-term interest rates and providing ready available credit to troubled and fractured financial institutions.

Here is a brief about the different policy tools used by Federal Reserve; these tools are widely used by other countries too.

Open Market Operations – The Federal Reserve considers it as the principal tool for implementing monetary policy. The objective of OMO can be a desired price (Federal Funds rate) or a desired quantity of reserves. The federal funds rate is the interest rate at which the depository institutions lend balances at the Federal Reserve to other depository institutions overnight (similar to Call rate in India).

However, Fed objectives on OMOs have varied over the years. During the 1980s, it concentrated on attaining the specified level of the federal funds rate and in 1995, it explicitly targeted federal fund rates. Table 1 explains the movement of Fed’s fund rates.

The Discount Rate – It is the interest rate charged by the Federal Reserve Bank to commercial banks and other financial institutions on loans under its lending facility – the discount window (Similar to Call Money in Overnight Segment). The Federal Reserve Bank offers three discount windows to depository institutions – primary credit, secondary credit and seasonal credit, each with its own discount rate. All discount window loans are fully secured.

In the primary credit program, the loans are extended for a very short term (usually overnight) for financially sound institutions. Those institutions which are not eligible for primary credit may apply for a secondary credit to meet short-term liquidity needs or to resolve severe financial difficulties. Seasonal credit is extended to relatively small depository institutions that have recurring intra-year fluctuations in funding needs, such as banks in agricultural or seasonal resort communities. The rates charged are minimum in Primary Credit followed by Secondary Credit while the discount rate for seasonal credit is an average of selected market rates.

Reserve Requirements

Against specified deposit liabilities, the banks are required to hold a minimum percentage of holding in reserve in the form of vault cash or deposits with Federal Reserve Banks. Reservable liabilities consist of net transaction accounts, non-personal time deposits and Eurocurrency liabilities. Since Dec 27, 1990, non-personal time deposits and Eurocurrency liabilities have had a reserve ratio of zero. Beginning Oct 2008, the Federal Reserve Banks will pay interest on required reserve balances and excess balances. The table 2 shows the reserve requirements as decided by Federal Reserve.

Interest on Required Balances and Excess Balances

The Federal Reserve pays interest on required reserve balances – balances held with Federal Reserve to satisfy reserve requirements and on excess balances – balances held in excess of required reserve balances and contractual clearing balances.

The interest rate on required reserve balances and excess balances is determined by the Federal Reserve Board. It gives the Federal Reserve an additional tool for the conduct of monetary policy.

Term Asset-Backed Securities Loan Facility

The Term Asset-Backed Securities Loan Facility (TALF) is a funding facility that will help market participants meet the credit needs of households and small businesses by supporting the issuances of asset-backed securities (ABS) collateralized by loans of various types to consumers and businesses of all sizes.

Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans.

Term Deposit Facility

It is a new tool announced in 2010 by which the Federal Reserve can manage the aggregate quantity of reserve balances held by depository institutions. It will facilitate the implementation of monetary policy. Funds placed in term deposits are removed from the accounts of participating institutions for the life of the term deposit and thereby drain reserve balances from the banking system. Reserve Banks will offer term deposits through the Term Deposit Facility (TDF), and all institutions that are eligible to receive earnings on their balances at Reserve Banks may participate in the term deposit program.

While the above mentioned policy tools are currently operative, some of the programs has been wound down on improved economic scenario. The Money Market Investor Funding Facility expired on Oct 30, 2009, and the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility were closed on February 1, 2010. Also, the final Term Auction Facility auction was conducted on March 8, 2010.

The world dynamics has changed; so with geo-political issues. PIIGS (Portugal, Ireland, Italy, Greece, Spain), once a flying and splendid investment horizon have been on the verge of sovereign crisis. We believe that the Keynesian has left a strong theory to be followed by US which have initiated many quantitative programs – QE-I (worth Trillion dollars) followed by QE-II (worth US$ 600 billion). 

Happy Reading!

Source: Federal Reserve

The New Financial Landscape – Islamic Finance to fuel the growth

The economic crisis followed by the revival; world markets are poised to grow at an unexpectedly high rates barring some uneven European’s crisis and Korean’s geo-political tensions. However, Asian region capturing 50 per cent of world population has its own growth story, thanks to high consumption story. Emerging from the worst of the crisis, the global financial landscape will be a markedly different one from before. India and China’s stories support the theory.

Asia accounts about 60 per cent of world Muslim’s population which makes a case for Islamic Banking; however the industry has been facing challenges. Mr. Ng Nam Sin, Assistant Managing Director, Monetary Authority of Singapore says that

The industry faces several challenges.  Let me just highlight three key issues facing Islamic finance in Asia. Firstly, as was noted by Governor Rasheed Al Maraj, most Shariah-compliant banks like conventional banks need to continue to improve their risk management and corporate governance standards.  Asset-liability management, liquidity and risk concentrations are some of the key issues confronting financial institutions.  They need to ensure their business models are sustainable in the long-term. 

Secondly, the Islamic Financial Services Board (IFSB) has pointed out that Islamic banks need an international Islamic short-term liquidity market. This will further facilitate asset-liability management.  In Asia, we need an active pan-Asian Islamic securities market to provide more short-term liquid instruments for Islamic banks as they expand across the region.  It is encouraging that more countries in Asia are now familiarising with Islamic finance and its structures, and have expressed interest to issue sukuk.  Several are adopting the necessary legal and regulatory frameworks to enable Islamic finance to take root and grow.  More focus on growing the issuance of tradeable liquid instruments, over time, would help to improve liquidity and cross-regional flows.

Thirdly, a shortage of human capital; the number of financial professionals who are well-versed in Shariah-compliant products is still relatively small.  We need more universities and training institutes to offer better quality education and training in Islamic law and finance in order to meet the rising demands of the industry as it embarks on the next phase of growth.

Read more on it.

In this phase of organic transformation, Singapore has emerged as the major economy in developing Islamic Finance. Singapore boasts of largest Real Estate Investment Trust (REIT). Its Singapore Management University has set up an Islamic Law and Finance Centre, the first institution in the world to combine Islamic Law, Banking and Finance programmes in a single, multi-disciplinary university centre.

Some specific Muslims organizations have always been in focus for all wrong reasons which deteriorate their images all over the world, especially after 09/11. If they just dig their strengths and do well for their communities and bring a change in their thinking, many Muslim dominated countries will get benefitted.