Bet­ter ways to clean up mu­tual funds

SEBI should at­tempt to de­clut­ter the MF in­dus­try with­out sti­fling in­no­va­tion

The Hindu Business Line - - THINK - AARATI KR­ISH­NAN

Last week, after years of de­bate, the Se­cu­ri­ties and Ex­change Board of In­dia em­barked on a Swachh Bharat-type mis­sion to de­clut­ter the Indian mu­tual fund in­dus­try. Such spring-clean­ing is sorely needed. The MF in­dus­try has seen its fair share of ‘con­sol­i­da­tion’ in the last decade but this has made very lit­tle dif­fer­ence to the num­ber of schemes on of­fer. The 45 As­set Man­age­ment Com­pa­nies (AMCs) to­day of­fer over 1900 schemes be­tween them.

Vaguely de­fined in­vest­ment man­dates add to this be­fud­dling cock­tail of choices. It is quite usual in the Indian con­text for a ‘bluechip’ eq­uity fund to park a third of its port­fo­lio in mid-cap stocks and for a liq­uid fund to in­vest in barely liq­uid AA-rated bonds.

SEBI’s lat­est cir­cu­lar on cat­e­gori­sa­tion and ra­tio­nal­i­sa­tion of mu­tual fund schemes pro­poses three new rules. One, all AMCs are hence­forth re­quired to clas­sify their ope­nend schemes into just five cat­e­gories — eq­uity, debt, hy­brid, so­lu­tionori­ented schemes and oth­ers (only in­dex funds and fundof-funds). Two, they should fur­ther clas­sify their schemes into SEBI-ap­proved types. It has pro­vided a ready­made list of 10 types of eq­uity funds, 16 types of debt funds, 6 types of hy­brid funds and 2 so­lu­tion-based prod­ucts. No AMC can run more than one scheme un­der each type. Three, to en­sure truth in la­belling, SEBI has asked all AMCs to en­sure that their schemes stick to man­dates de­fined by it. For in­stance, it de­fines a large-cap fund as one which in­vests a min­i­mum 80 per cent in the top 100 stocks by mar­ket cap­i­tal­i­sa­tion. A fo­cussed fund can­not own more than 30 stocks. A long du­ra­tion fund needs to main­tain a min­i­mum port­fo­lio du­ra­tion of 7 years.

AMCs are ex­pected to eval­u­ate all their schemes un­der this new frame­work and get back to SEBI with con­crete plans to merge, wind up or tweak the ones that don’t fit in. But elab­o­rate as they are, these rules don’t com­pletely solve the prob­lem for fund in­vestors. On some counts, they may also sti­fle in­no­va­tion.

Rigid man­dates

SEBI’s at­tempt to make schemes de­fine their la­bels bet­ter and stick to them is cer­tainly wel­come. After all, when a re­tiree buys a large-cap fund, he’s hop­ing to own es­tab­lished firms with lower volatil­ity in stock prices. If that fund drifts into mid-cap stocks, it is longer a good fit for his risk pro­file. Now, he can be fairly cer­tain of what he’s buy­ing and the scheme will not even have wrig­gle-room on what it treats as a large, mid or small-cap stock. In debt schemes, there is sim­i­lar clar­ity on du­ra­tion, al­low­ing in­vestors to match their own hold­ing pe­riod with the funds’.

But then, the mar­ket cap tilt of an eq­uity fund or the du­ra­tion pol­icy of a debt fund is just one as­pect of the in­vest­ment man­date that in­vestors would be in­ter­ested in. A liq­uid fund which sticks to the SEBI def­i­ni­tion on 91-day ma­tu­rity can still take out­sized risks by own­ing Arated cor­po­rate bonds. In an eq­uity fund, it mat­ters a great deal to the in­vestor whether the scheme takes cash calls, and whether it owns a con­cen­trated port­fo­lio.

This is why, in­stead of spoon­feed­ing AMCs with rigid man­dates, it may be bet­ter for SEBI to pro­vide some in­dica­tive man­dates and then al­low AMCs to come up with new ones on their own. It can, how­ever, in­sist on the man­dates be­ing pre­cise and quan­tifi­able. For in­stance, every eq­uity scheme can be re­quired to state up­front its mar­ket cap lim­its, cap on in­di­vid­ual ex­po­sures, style of in­vest­ing and cash­hold­ing lim­its. Schemes which stray from their stated man­date must be flagged and pe­nalised.

Not so sim­ple

SEBI’s re­quire­ment that all AMCs have only one scheme of each ‘type’ is in­tended to sim­plify choices for in­vestors and re­duce du­pli­ca­tion. There are in­stances in the in­dus­try of the same fund house of­fer­ing two ELSS schemes, two bal­anced funds or mul­ti­ple cor­po­rate bond funds. This doesn’t just con­fuse in­vestors, it also cre­ates tricky al­lo­ca­tion is­sues. Which of the schemes with sim­i­lar man­dates should get the more ex­pe­ri­enced fund man­ager or the bet­ter stock picks? The new rules may force such schemes within an AMC to merge or wind up.

But then, given that each one of the 45 AMCs can still of­fer 34 dif­fer­ent types of schemes, it is doubt­ful if the sim­pli­fi­ca­tion ob­jec­tive will be met. In­vestors can still the­o­ret­i­cally be bom­barded with 450 dif­fer­ent eq­uity schemes, 720 debt schemes and 270 hy­brid schemes, apart from an un­lim­ited num­ber of sec­tor funds and ETFs. That closeend schemes have been kept en­tirely out of the purview of these reg­u­la­tions is an­other big con­straint. With

SEBI tight­en­ing the screws on ope­nend scheme launches in re­cent years, AMCs have been go­ing the whole hog on close-ended schemes. At last count, the in­dus­try man­aged 1084 close-end schemes (as op­posed to 829 open-end ones) which are un­af­fected by these reg­u­la­tions.

Whither in­no­va­tion?

Fi­nally, there’s the ques­tion of whether SEBI’s cookie-cut­ter ap­proach to clas­si­fy­ing funds will sti­fle in­no­va­tion. In draw­ing up its list of ap­proved fund types, the reg­u­la­tor has mainly gone by the schemes al­ready of­fered by the lead­ing Indian AMCs. Most Indian eq­uity schemes al­ready de­fine them­selves based on mar­ket cap buck­ets and debt funds swear by du­ra­tion. But who is to say that this is the ideal cat­e­gori­sa­tion for in­vestors?

Many first-time in­vestors in debt funds, for in­stance, would like to own a long-term fund that de­liv­ers reg­u­lar in­come that is slightly higher than a bank FD. They couldn’t care less about the du­ra­tion pro­file. First-time eq­uity in­vestors may pre­fer a multi-cap fund that pro­tects down­side risk by mov­ing to cash. But there is no clas­si­fi­ca­tion for such in-be­tween prod­ucts.

Sea­soned MF in­vestors may like to grad­u­ate to so­phis­ti­cated global prod­ucts that go be­yond the cur­rent fund types. Ab­so­lute Re­turn Funds, Tar­get Date Funds or So­cially Re­spon­si­ble Funds are yet to de­but in In­dia. Let’s not for­get that, not long ago, even Eq­uity Sav­ings Funds, Credit Op­por­tu­ni­ties Funds and Fo­cussed Eq­uity Funds were alien con­cepts but have been ush­ered in by in­no­va­tive AMCs.

Over­all, SEBI should prob­a­bly be more flex­i­ble about its idea of pi­geon­hol­ing all MF schemes into pre-set cat­e­gories. If a sim­ple menu of of­fer­ings for first-timers is its goal, it must en­cour­age all AMCs to of­fer at least one go-any­where eq­uity fund and one go-any­where debt fund on their menu, with­out forc­ing the in­vestor to make com­pli­cated choices on mar­ket cap, style, du­ra­tion or credit. Let the sea­soned in­vestors be of­fered as many fund cat­e­gories or types as they would like.

In fact, more than such ra­tio­nal­i­sa­tion, it is thriv­ing com­pe­ti­tion that AMCs in In­dia need, to of­fer their in­vestors a bet­ter deal. SEBI should make every ef­fort to en­sure that Indian in­vestors have ac­cess to ro­bust new cat­e­gories of pas­sive funds that give ac­tive fund man­agers a good run for their money.

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