SEBI plays ‘HOLI’; introduces color labels for Mutual Funds

If you ask a retail investor if he has made money in the last 5 years despite the broader indices hovering in the range of 19,000 to 20,000, the answer would be no and in fact they would swear not to touch the capital market again. So, the question arises, “Have the Mutual Funds lost the charm” or “Have they been mis-sold which investors have realized and vowed to give a pass”? Probably these questions must be the pondering in the mind of SEBI, India’s Capital Market Regulator while zeroing in a way to make Mutual Fund a simpler investment product. And they played ‘HOLI’ by assigning Color Labels to different categories of Mutual Funds to define the level of risks – High, Medium or Low. But the product labeling comes with a disclaimer “Investors should consult their financial advisers if in doubt about whether the product is suitable for them” for investors who are still not able to decide the fund based on their objectives and investment risks. Since ‘Red’ invites a bad rapport and somehow gives a negative signal, SEBI played safe by assigning a Brown Color for high risk products so that investors should not disown those products at all. So, they assigned colors – Brown, Yellow and Green for High Risk, Medium Risk and Low Risk products respectively.

So, the funds would be labeled based on the parameters as given below:

1)      Nature of Scheme such as to create wealth or provide regular income in an indicative time horizon (short, medium or long term)

2)      A brief about the investment objective i.e. the product aims to invest in equity or equity related securities of, say, top 200 companies by Market Capitalization.

3)      It will also label the level of risk by assigning the respective color box along with the narration of risk i.e. High, Low or Medium

The SEBI also mandated that these labeling should also be disclosed in front pages of all related documents like Common Application Form and NFO Forms, Scheme Information Documents (SIDs) and Key Information Memorandum (KIM) and in all kind of advertisements wherever displayed be it print, tv or online.

The ruling would be applicable with effect from July 01, 2013 to all existing schemes and all future schemes to be launched. Fund Houses may choose to follow the provisions before the effective date.

Will it help first time investors?

If a grocery buyer goes to the market to buy an edible product, he selects the product based on the green veg label or red non-veg label based on his requirement. However, he may not be able to understand its constituents if he is not literate. Ditto may be the case with retail investors with these MF labels; they may end up buying the mutual fund depending upon his risk appetite but the product may not be really suitable for them. So, they must seek help from the Financial Advisor who will help them in selecting the right product.

So, will the advisor get away even if he has recommended a wrong product? It does not seem easy in the current given scenario. Recently AMFI introduced an Employee Unique Identification Number (EUIN) where the advisor needs to mention this unique id in the application form and would be answerable for the logic of investment irrespective of wherever he moves as the code remains unique to him/her only.

Moreover, it is also suggested that investors must undergo risk profiling taking into account of their income, age, assets, liabilities and other goals and then reach on their risk appetite. Apart from the performance, portfolio philosophy and fund management style, one should also look into costs which are measured by expense ratio and exit loads.

What turns off?

Though SEBI tried keeping three simple colors – Brown, Yellow and Green, it failed to answer for the vast product varieties within the same categories.

Exempli Gratia - Within equity category, there are many sub categories like Large Cap, Small Cap or Thematic. Though they all have equity as common constituents, the constituents differ in their inherent risk which may deviate very high. A pure FMCG fund and a Pure Diversified Equity Fund would be labeled as Brown Box with High Risk; however, both have separate set of risks defined internally.

Also AMFI must market the new labeling actively and position it in a way that investors don’t end up in same hassles of selecting the wrong Mutual Fund which does not align with the investment objective and horizon.

Laudable ground work; confidence still shaken

Though it is a laudable effort by SEBI to educate investors and help them take an informed decision, the time will say whether it really helps to bring back the lost charm in Mutual Funds. Or will the product labels lose its spark despite a colorful mix? Despite all these measures, it is very important to instill the confidence wobbled in recent past which is leading to continuous outflows of retail money from the Mutual Fund industry. Constructive Investors’ Education is the mother of all steps. Hope the SEBI’s new ‘HOLI’ colors make a colorful impact in investors’ life. Happy Holi!

Happy Investing!

SEBI Regulations - A cup of half-emply, half-filled

The SEBI board in its today meeting announced major decisions which are as mentioned below:

a)      Fees on Mutual Fund transactions: Healing the wounds of Mutual Fund Industry which had been almost killed since the ban of entry load in Aug 2009, SEBI imposed a fee of Rs. 100 per transaction on Mutual Fund investments for existing investors while new investors would have to cough up Rs. 150 on investment above Rs. 10,000. This is a break through decision for bleeding distributors’ community to compensate them to penetrate into retail segment.

The per transaction fee would be Rs. 100 for investments above Rs. 10,000 including Rs. 50 per new folio creation i.e. first time Mutual Fund investor. This may be deterrent to investors as distributors may promote new folio each time investors put money into Mutual Funds. For SIPs, the transaction charges can be recovered in 3 or 4 months. However, it is still not clear whether the new SIP transactions of less than Rs. 10,000 would have one-time fee of Rs. 150 only recoverable on 3 or 4 months. Investors investing directly through AMCs shall not require paying any transaction fee or folio creation fee.

This move is seen as back door imposition of entry load in Mutual Fund which has been banned in Aug 2009. The ruling had hit Mutual Fund inflows severely and had de-incentivized IFAs and distributors to promote Mutual Funds.  

The regulator also put onus on AMCs to do due diligence and regulate distributors alternatively. The diligence process would be applicable for those distributors satisfying one or more of the following criteria:

1)      Multiple point presence in more than 20 locations

2)      AUM raised over Rs. 100  crore across industry in the non-institutional category but high networth individuals (HNIs)

3)      Commission received of over Rs. 1 crore p.a. across industry

4)      Commission received of over Rs. 50 lakh from a single mutual fund

b)      New Takeover regulation: The regulator raised the initial trigger threshold to 25 per cent from the existing 15 per cent and also abolished the non-compete fees. All shareholders would be given exit at the same price. It also increased the minimum offer size from the existing 20 per cent of the total issued capital to 26 per cent of the total issued capital. This is a welcome move for institutional investors who were not able to put money in listed companies for more than 15 per cent of their issued capital in fear of mandatory requirement of additional 20 per cent open offer. Now, investors can buy up to 25 per cent stake without making an open offer.

c)       Guidelines for Infrastructure Debt Funds (IDF): The SEBI also allowed existing Mutual Funds to set up IDF. Existing companies in infrastructure financing for a period not less than five years can also set up Mutual Funds exclusively for the purpose of launching IDF scheme. As said in earlier document by the Finance Ministry, it would invest 90 per cent of its assets in the debt securities of infrastructure companies or SPVs across all infrastructure sectors. This new proposal may open a new financing window for the government who has been looking for a fund equivalent to $ 1 trillion to build the infrastructure in India.

d)      Reduction in no. of pages of IPO form: The SEBI allowed an approximate 50 per cent reduction in number of pages and asked for standardization of form and a single form for ASBA/Non-ASBA. It has also asked to put track record of lead managers in Bid-cum-Application Form and Abridged Prospectus. This would a boon for all investors who have to go through the pain of filling so many information in a larger sized form. 

The SEBI also announced various other regulations and guidelines related to simplifying and rationalizing trading account opening process and also harmonized the new KYC applicable for all transactions. The guidelines have been framed keeping the investors at benefit. Under former SEBI C B Bhave’s chairmanship, there had been a number of investors’ friendly steps but too many guidelines had been killing the industry especially Mutual Fund industry. The new chairman U K Sinha, an IAS veteran and the former Chairman of UTI Mutual Fund had promised some incentives to distributors/IFAs to sell Mutual Funds which to a large extent seemed justified in today guidelines. However, at the end, investors would be paying some additional charges on their Mutual Fund investments.

Happy Investing!

-         Amar Ranu

MOSt Shares M50 – Is it another offer in the crowd?

Recently SEBI’s Chairman C B Bhave commented if 3000 schemes flooded in the industry served a purpose to investors’ fraternity as they have failed to convince the investors of the long-term benefits of their products. He also suggested that the mutual funds should provide better returns by rolling out simpler products. Now coming to another zone where Mutual Funds continue to roll out new NFOs – HDFC Gold ETF, Peerless Income Plus Fund, MOSt Shares M50 ETF, Taurus MIP Advantage, Benchmark Short Term, Axis Triple Advantage and many Fixed Maturity Plans (FMPs). I have been wondering if I am an investor which one I should choose. As a simple investor, my aim should be to maximize returns with least volatility; also I should bear minimal costs.


Among the above captioned NFOs, all the NFOs were more or less similar to the existing plans offered by another fund houses; I found a unique offer by Motilal Oswal AMC with its maiden NFO MOSt Shares M50 ETF. Though the ETF concept is new in India and has not been well received by investors yet, ETFs are on high. Historically, it has grown exceptionally even in intermittent market. Let me give out in detail why MOSt Shares M50 ETF is unique and investors’ friendly.

Product Features

As claimed by Motilal Oswal Mutual Fund, MOSt Shares M50 ETF is India’s 1st fundamentally weighted ETF based on the S&P CNX Index (Nifty). Logically, it is the remixed version of Nifty 50. The fund house has created its own basket “MOSt 50 Basket”, intellectually owned by MOAMC and managed by India Index Services & Products Ltd. (IISL). The weights of stocks in MOSt 50 Basket will be decided by their pre-defined methodology based on stock’s fundamentals (ROE, Net Worth, Retained Earnings and Valuation).

The fund aims to generate investment returns with minimal costs and active investment style. With no entry and exit load, the investors get another opportunity in terms of liquidity. The fund manager will invest 95-100% of the money in MOSt 50 basket and the exposure to fixed income and money market instruments along with cash call will be restricted to 0-5% of the total money invested.

Investment Strategy

The fund has reworked the weights of stocks in Nifty based on its own defined fundamentals such as Return on Equity, Net Worth, Retained Earnings and Price. They have designed the capital allocation strategy of the MOSt 50 basket to reduce the risk associated with price volatility of individual constituents. The table 1 defines the basket classification of MOSt 50 Basket.

So, some of the companies will be more dominant than others based on the current methodology.

Back Testing

The fund has done the back-testing with current methodology for the last 3-year period and the portfolio has given an additional alpha (excess of returns over its benchmark, in simple terms) of 13.2 per cent. It has also beta value of 0.94 against Nifty beta of 1.

Should you buy?

As far as the ETF story is going on, it has been building up in India. People have started recognizing the importance of ETFs as fund managers have failed to outperform the benchmarks over a longer period. Moreover, this new ETFs, also called as active ETF scored over others and provide uniqueness in terms of simplicity and maximization of returns over a longer period.

Life Insurance – A Distant Dream for Indians

India, a home to 1.15 billion people and the world’s second largest population stands abysmally low in terms of social security and human needs measures. Since independence, the Government of India introduced many measures to improve the economic conditions of this country. This included various social security schemes, the prominent being ESIC and EPFO followed by some recent measures such as MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act), National Rural Health Mission etc. The history of Insurance in India dates back to British colonial period, early 19th century. Since then, a lot of reforms came in existence, particularly for Life Insurance. Despite all measures, the penetration of Insurance is still ranked the lowest amongst other countries.

India is an under-insured country and the insurance penetration level stands abysmally low at 2 per cent of the population, the general insurance penetration stands at 0.6 per cent only. With a vast population of 1.15 billion, there is an immense opportunity that needs to be tapped. An estimated 80 per cent of the Indian population is without Life, Non-Life and Health insurance. However, the Indian Insurance industry is poised to grow robustly with a clear path set along the growth trajectory. In terms of total business, the Indian Life Insurance industry has grown from US $ 8.87 billion in Fiscal Year 2005-06 to US $ 41 billion as on Jan 2010, thus, giving an absolute increase of 362 per cent. In an average, the industry has been growing at a rapid pace of 30 – 34 per cent annually, as per Life Insurance Council. LIC, being the earliest player and set up under the Life Insurance Act in 1956 has played a dominant role in spreading its wings across all nooks and corner of India. However, the entry of private insurance players changed the dynamics of Indian Insurance industry.

As regard to the FDI being capped to 26 per cent in Life Insurance, it created an additional opportunity for foreign players who have been looking to tap the untapped insurance potential in India. The total FDI being routed to India under FDI to Insurance is US $ 525.6 billion. The government is keen to reintroduce the Insurance Bill which proposes to increase the FDI level to 49 per cent from the current level of 26 per cent.

But the question arises, why India is still tagged as Under Insurance industry? Have the government not done enough to increase the penetration level to all corners of India?
Why Insurance is sold in India?

Insurance policies are sold in India unlike its developed counterparts where it is sought after. No doubt, the major reason is poverty and low level of penetration in rural areas. The major population which is largely based in rural areas has low level of financial knowledge. Since, majority of India’s population is living below the poverty level (BPL), they are more interested in living their livelihoods instead of protecting their futures against any mishaps. Moreover, the Government of India does not run any social security schemes on its own unlike in other developed countries which contribute on their behalf. The lack of a proper path hampers the penetration level in insurance. One of the tools to measure the insurance development is per capital spending on insurance i.e. insurance density. Based on this measure, India ranks among the lowest spending nations in Asia in respect of purchasing insurance. Another factor that has been slowing the improvement of insurance density in India is its relatively high population growth rate.

The low income level (average per capital income being at Rs. 44,345 in 2009-10) also deters individuals to ask for insurance as a product to safeguard their futures. Moreover, insurance is not compulsory in India except Motor Third Party Liability. There is no other compulsory insurance in India. In a nut shell, the awareness is poor because insurance was not sold for years – it was bought. However, the mushrooming of private insurers has helped in a big way to push insurance products. Apart from the usual agent-client relationships, these insurers have been using new innovative measures such as Direct Marketing, Digital Marketing etc. Since Mobile has reached deeply in every nook and corner of India, insurers have been using it in a big way to push products.
What the government has done to boost Insurance in India?

• FDI up to 26 per cent permitted under the automatic route subject to obtaining a license from the Insurance Regulatory Development Authority (IRDA)

• Private insurance players have been allowed into the Insurance business; earlier it was dominated by LIC

• Set up of Insurance Regulatory Development Authority (IRDA) to regulate the insurance industry

• Set up of Foreign Players in conjugation with the domestic players

• Defining new rural business commitments in terms of number of life insurance policies sold and total premium collected, thus, asking allowing life insurance companies to set up their shops in rural and untapped areas
Entry of Private Players in Insurance Business

After the Government of India (GoI) liberalized the insurance sector in March 2000 with the passage of the Insurance and Regulatory Development Authority (IRDA) bill, it allowed the setting up of private and foreign insurance players in 2000. As a result, the total number of Life Insurers increased to 23 as of April 2010, as per IRDA report. The private players in partnership with foreign players brought new dimensions in the industry along with technological know-how, thus, reducing the operational costs and bringing new efficiency in the industry. The scaling up of private insurers reduced the market share of LIC India which forced them to overhaul their set up and its way of functioning. Entry of private insurance players brought alternative distribution channels to suit customers’ needs. So, the industry has moved from the typical meeting between the customer and insurance agent as seen earlier to new technology. New companies are emphasizing on speed, convenience and ease of transactions. Though there have been some mis-selling being reported, it is the regulatory loopholes which they have been exploiting and in the time to come, it will disappear gradually. IRDA has announced a series of regulations to regulate the insurance industry and also improved the solvency ratio, a measure to test the robustness and strength of Insurance Company. The insurance sector is set to witness a sea change in the way the businesses were traditionally done, with new innovative products, distribution network etc. Insurance players have also been experimenting direct marketing plans and have been successful too, to some extent.
Scope of Private Insurers in future

The future looks promising for Indian insurance industry. The private players have reached to untapped area. In some products like annuity or pension products business, the private insurers have covered a significant portion of the total market share. The most popular product Unit Linked Insurance Product (ULIP), locked in the spat of two regulators i.e. IRDA and SEBI have gained significantly, thus, creating a virtual monopoly in terms of over 90 per cent of the new customers. The government also moved and set up Micro Insurance Act to allow insurance companies to roll out Micro Insurance products suited for low income level population. With increased consumption power and overspending in rural areas, these rural folks are going to be the major customers for the economy. Moreover, the government is committed to improve its economic figures and it is bound to happen if it improves the social security conditions in rural areas in terms of Micro Insurance policies.

The Road Ahead

The saturation of insurance markets in various developed economies has made India an attractive market for foreign players. As per a report “Booming Insurance Market in India (2008-2011)”, the life insurance premium in India is projected to grow US $ 266 billion by 2010-11. The main objective is to make the participants familiar with the role of insurance in economic development.

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!

 

 

SEBI’s ruling on Mark-to-Market may shun the attractiveness of Ultra-short term funds

Since the SEBI made mandatory for Liquid Fund managers to invest in papers with maturity of up to 91 days only, the Liquid Funds lost sheen among institutional investors due to reduced portfolio returns. This allowed the market participants to shift its focus to Ultra Short Term Funds (erstwhile called as Liquid-Plus Funds). Thanks to superior returns and tax benefits over Liquid Funds, Ultra Short term funds have found a favour among all class of investors.

However, the market watchdog SEBI still not very confident about the credit stability in the market issued another directive asking all mutual funds to value money market and debt securities with maturity over 91 days (or with maturity up to 182-days) on a mark-to-market basis with effect from July 01, 2010. The ruling will require all fund managers to factor in any movement in securities prices on a daily basis to calculate the Net Asset Value (NAV) of fund. The new valuation method may increase the volatility of Ultra Short Term Funds while Liquid Funds being shorter tenure funds will be less volatile. Currently securities having maturities over 182 days are already valued at daily weighted average (mark-to-market) method. The move will ensure that the Liquid Funds and Ultra Short Term Funds are undeniably liquid by asking them to be valued in a more transparent manner.

Ultra short term schemes which comprise 40 per cent of Indian Mutual Fund industry’s asset under management (AUM) of Rs. 7.59 lakh crore have been fetching returns in the range of 5-5.5 per cent having an edge over its sibling Liquid Funds fetching returns in the range of 4-4.25 per cent. The debt instruments held by Ultra Short Term Funds (or Liquid-Plus Funds) have a longer tenure i.e. the average maturity of these funds is comparatively higher than that of Liquid Funds. Long term papers (over 91 days) help fund managers to generate extra returns over short term papers (up to 91 days). Recently the RBI hiked the CRR by 75 basis points which increased the returns on Commercial Papers and Certificate of Deposits by around 100-150 basis points.

In the last few months, there have been continuous net outflows from Liquid Funds due to high dividend tax structure and restrictions to invest in papers having maturities up to 91 days only. Liquid Funds charge a dividend distribution tax (DDT) of 28 per cent unlike in Ultra Short Term Funds where the DDT is 14 per cent for individual and 22 per cent for corporate, thus, clearly giving a tax advantage of 8 per cent. Treasury Officials, CFOs etc prefer Liquid Funds and Ultra-Short Term Funds over Banks’ Fixed Deposits where interest income is charged at 33 per cent.

By issuing out the current directive, the regulator SEBI wants to make sure that the Oct 2008 Credit Crisis is not repeated where the RBI has to open a lending window for Mutual Funds for a limited period to ease out the crisis. However, the industry will continue to enjoy additional returns in Ultra Short Term Funds, though at a slightly higher risk as long as the tax-arbitrage is in existence over Liquid Funds and banks’ Fixed Deposits. The market will actively watch the upcoming Annual Budget on Feb 27, 2010 where the government may take away the tax arbitrage in Ultra Short Term Funds to make sure that Banks’ FDs are actively used for placing excessive unused funds, thus, bringing out a kind of stability in the credit market.