New Mutual Fund regulations to benefit investors

The Mutual Fund Industry has a happy ending in 2009 with assets growing to a fabulous high. The industry also saw some investors’ friendly regulations turning to be unfriendly for distributors and IFAs. Starting from No-Load scenario post Aug 01, 2009 to host of other regulations, SEBI threw another set of regulations to all fund houses in the month of March 2010 signaling another round of reforms in world’s fastest growing Mutual Fund industry.

 

Reduction of NFO’s Period

Starting with the list, SEBI reduced the New Fund Offers (NFOs) duration to a maximum of 15 days from 30 days for open-ended funds and 45 days for close-ended funds. On completion of NFO period, the units’ allocation and dispatch of Statement of Accounts (SoAs) are required to be done within five business days after the closure of NFO period. The rule also says that Mutual Funds shall make investments out of NFO proceeds only on or after the closure of the NFO period. The new rule is effective from July 01, 2010.

 

Introduction of ASBA for MF Investors

SEBI introduced ASBA or Applications Supported by Blocked Amount in July 2008 for all equity investors investing in IPOs or Right Issues to make effective use of money put into it. Under this, the application money you put for subscribing to IPOs/Right Issues does not leave your bank account unless the allotment is done. So, there is no need for refund of money, thus, reducing the operational issues and you also earn interest even on blocked amount. Now, this facility is extended to Mutual Fund investors putting money in NFOs. Nevertheless ASBA means little for investors as most investors put money only on the last day of NFO period. Moreover, SEBI has mandated that the fund house has to allot units five days after the closing of NFOs.

 

Dividend distribution from realized profits

SEBI also mandated that the dividends to be paid to investors have to be out of realized profits only. Currently, some Mutual Fund houses pay dividends from their Unit Premium Reserve instead of booked profits. E.g. A fund XYZ has an initial NAV of Rs. 10. The amount Rs. 10 goes to an account called as Unit Capital or Face Value. Let us say the NAV grows to Rs. 15. The appreciation amount of Rs. 5 goes into a separate account called as Unit Premium Reserve (UPR). This ruling might affect many fund houses which used to declare dividends as a marketing gimmick to attract inflows. After this ruling, many fund houses have cancelled the dividends declared.

 

FoFs commission to decline

In case of FoFs, AMCs have been entering into revenue sharing agreements with offshore funds in respect of investments made. Typically they get around 50-100 bps from Offshore Funds along with 75 bps which they charge from investors. Out of 75 bps, they used to take care of marketing expense and other expenses. The Fund Houses used to pocket the sharing revenue (50-100 bps) from Offshore or Local Funds where they have invested. Post this ruling, an FoF may not be a profitable avenue for Mutual Funds in India.

 

Adherence to Corporate Governance

Since Mutual Funds invest in companies on behalf of investors, SEBI wants them to be more participating in company affairs and voice their opinions. SEBI has mandated that Mutual Funds must disclose participation in company’ annual or other affairs such as exercising voting rights in mergers, AGMs, changes to capital structure, appointment or removal of Directors, stock option plans and other management compensation issues and many more in their website and Annual Reports.

Following Satyam scam, SEBI wanted the companies to be more accountable for their acts and business rules and Mutual Funds which represent a group of investors will be the best fitted for this role.

 

Conclusion

 Time to time, SEBI comes out with different regulations which ultimately helps retail investors. Thanks to our robust financial system which surpassed the economic crisis of 2008 post Lehman collapse, SEBI wants to ensure that India remains decoupled with financial breakdown which galloped major big names. Moreover, SEBI wants to make MF and its fund managers more transparent and accountable for investors’ money. However, the challenges lie ahead how the fund houses implement these changes. Happy Investing!

 

 

Too many players, too many regulations…

India remained coupled with the ongoing global financial crisis albeit the extent of losses was small as compared to other nations where a lot of financial institutions collapsed. India, the favorite destination for foreign money witnessed an unusual concept ‘flight to safety’ which resulted in sharp depreciation of mutual funds’ assets under managements (AUMs). Some mutual funds defaulted in payments too but the timely action by SEBI along with RBI helped Indian mutual fund industry in achieving new heights in terms of AUM. Currently, the whole industry AUM stands at Rs 7.63 lakh crore with 38 pillars supporting the base. Many players entered the bandwagon witnessing the high growth rate year after year. SEBI announced a series of regulations in 2009 to protect the interests of investors and improve the liquidity conditions. SEBI started the year prohibiting the declaration of indicative portfolios and indicative yields in Fixed Maturity Plans (FMPs) by mutual fund and its distributors. It also directed liquid fund schemes to purchase debt and money market securities with maturity of up to 91 days only effective from May 01, 2009. It also directed all mutual fund players to discontinue the nomenclature of ‘liquid plus schemes’ as it gives a wrong impression of added liquidity. The above regulations were directed by SEBI witnessing the serious liquid crisis in Oct 2008. Investment in Liquid Fund schemes with papers with maturity up to 91 days only has drastically reduced the returns from 7-8 per cent to 2.5-3 per cent compounded annually. This has resulted in mass redemption from liquid fund schemes.
In India, mutual fund investment is a push-strategy rather than a pull strategy as mutual fund distributors sell the products in lieu of high upfront commissions paid from investors’ investments. The SEBI announced the most awaited decision of the Indian mutual fund history where it directed the mutual fund houses to scrap all entry loads effective from Aug 01, 2009 and empowered the distributors and independent financial advisors (IFAs) to negotiate the commission for the services rendered. The retail investors welcomed the ruling while the distributors and IFAs opposed the decision as their earnings were at stake. Indian investors are not comfortable in writing another cheque for distributors. The above ruling created a stir in mutual fund inflows in equity category and the investment dropped drastically month after month. Some large mutual fund houses dig their profits to incentivize the distributors and IFAs while it became a question of survival for small mutual fund players. Fund houses reacted by increasing the exit loads which were also later regulated by SEBI putting a cap up to 1 per cent for all redemptions within one year and no exit loads beyond 1 year. To some extent, fund houses started pushing Portfolio Management Services (PMS) where it earns a fixed return in lieu of services rendered.
The cautious approach by SEBI in regulating Indian mutual fund industry and empowering the investors with improved investment conditions resulted in an increase in total assets under Indian Mutual Fund houses. However, the equity schemes continued to witness the lackluster in terms of investments.
Come to Nov 30, 2009. The retail investors have found another opportunity in terms of investments. Mutual funds units are now allowed to trade through registered brokers of recognized stock exchanges and NSE has already provided an online trading platform to all brokers. Thus, the need for enhancing the reach of mutual fund schemes to more towns and cities will be addressed through this channel. The existing secondary market set up in 1500 towns and cities will provide another opportunity to retail investors to invest in mutual funds. To some extent, the issue of holding multiple statements of accounts would be taken care and all the mutual fund units would be in dematerialized form.
But the question remains - are we ready to swallow too many regulations in such a short span of time? May be or may not be. SEBI could have been slow in introducing the exemption of entry loads in a phased manner so that it could give some time to IFAs to settle with their new business environments. As per ICRA Online report, the average maturity period for equity stands at 2-3 years much lower than its fundamental rule of 5-10 years. Equity has always been termed as a long term investment product but the recent ruling of allowing mutual fund units may result in increased churning of mutual fund investments. Moreover, the transaction charges as levied by brokers stands at 0.3-0.5 per cent for retail investors on either side trading, thus, making it 0.6-1 per cent on both side transactions. Apart from this, the brokers may charge an additional fee for recommending mutual fund scheme to investors. Thus, the whole concept of zero entry-load vanishes and moreover, the churning will also increase putting an extra onus in terms of increased fund management charges as portfolio turnover ratio will increase. Mutual fund houses will also benefit in terms of frequent exit loads being charged from investors.
No doubt, SEBI rulings will help retail investors with improved investment environment but it should also monitor the other anomalies as mentioned above. Investors must have some reasons to smile and become an informed and disciplined player.