Reg­u­la­tion 3.0—In­dian Mu­tual Funds

Mint Asia ST - - Money - MONIKA HALAN

The Se­cu­ri­ties and Ex­change Board of In­dia’s (Sebi) cir­cu­lar on mu­tual fund schemes’ cat­e­go­riza­tion and ra­tio­nal­iza­tion was re­leased on 6 Oc­to­ber 2017. The eight-page cir­cu­lar (you can read it here: bit.ly/2yux­ehs) comes at the end of many years of reg­u­la­tory nudges. What is the prob­lem that Sebi is at­tempt­ing to solve? Four problems. One, in the ab­sence of def­i­ni­tions from Sebi on what is a large-, mid- and small-cap cat­e­gory, there has been con­fu­sion about what an in­vestor is re­ally buy­ing. A large­cap fund could, there­fore, have stocks that would be counted as mid-cap if a dif­fer­ent def­i­ni­tion was used for short­list­ing a large-cap stock. Not just in­vestors, but third­party an­a­lysts too found the lack of an in­dus­try stan­dard dif­fi­cult to deal with.

Sebi has now laid down the rules of what th­ese three cat­e­gories are. A large-cap fund can buy stocks of firms that sit in the bucket con­tain­ing the top 100 stocks by mar­ket cap. A mid-cap fund can buy stocks from the bucket that has firms that fall between the 101st and 250th by mar­ket cap. A small-cap fund can buy stocks in firms that have a mar­ket cap from the 251st com­pany on­wards. The job of rec­on­cil­ing and putting out a list of th­ese stocks twice a year has been given to the in­dus­try as­so­ci­a­tion, As­so­ci­a­tion of Mu­tual Funds in In­dia (Amfi). This was a long over­due ba­sic hy­giene step that will al­low an­a­lysts and ad­vis­ers to put out re­search and ad­vice that does not have to worry about what def­i­ni­tion to use. If we are in a mar­ket that rests on dis­clo­sure, then it is the job of reg­u­la­tors to make dis­clo­sures mean­ing­ful. This is a step in the right di­rec­tion to bring an in­dus­try stan­dard in the Rs20 tril­lion mu­tual fund in­dus­try.

Two, over the years, clut­ter has built up in the mu­tual fund in­dus­try with too many sim­i­lar schemes even within a fund house. His­tor­i­cal rea­sons such as har­vest­ing the 6% new fund of­fer charge that was al­lowed till 2006, had en­cour­aged fund houses to launch sim­i­lar schemes to har­vest the charge. Merger of fund houses caused fund houses to have sev­eral sim­i­lar schemes. Smart com­pli­ance of­fi­cers also man­aged to get schemes past Sebi that es­sen­tially were no dif­fer­ent from ex­ist­ing schemes. Sebi is now defin­ing the mar­ket bet­ter. It has put out five broad mu­tual fund groups: eq­uity, debt, hy­brid, so­lu­tion-ori­ented and oth­ers. Each group will have cat­e­gories of schemes with as­set al­lo­ca­tion def­i­ni­tions. Each mu­tual fund will be al­lowed one scheme in each cat­e­gory. If a fund house has more than one scheme in a given cat­e­gory, it will have to merge it with the other scheme or shut it down. As an in­vestor, when you now look for a large-cap fund, you will see just one large-cap scheme from each fund house rather than four or five schemes in that cat­e­gory that some fund houses had. It makes com­par­i­son, choice and de­ci­sion-mak­ing eas­ier for in­vestors, an­a­lysts and ad­vis­ers.

Three, bal­anced funds were un­bal­anced with some fund houses stuff­ing theirs with far too much eq­uity. When in­vestors would com­pare re­turns across the bal­anced fund cat­e­gory, the funds with eq­uity higher than 70% would look much bet­ter than true-to-la­bel bal­anced funds. Sebi had stopped giv­ing ap­proval to new bal­anced fund schemes that did not stick to the 50:50 al­lo­ca­tion in the re­cent past, while al­low­ing older fund houses to run ex­ist­ing (un)bal­anced funds. Sebi has now split this cat­e­gory into three. Con­ser­va­tive hy­brid funds, known to­day as monthly in­come plans (MIPS), will have eq­uity up to 25% and the rest debt. Best for re­tired peo­ple seek­ing a monthly in­come, the name of the fund now does not mis­lead in­vestors into think­ing that the monthly in­come is as­sured. A bal­anced hy­brid fund will have an eq­uity al­lo­ca­tion of 40-60%. An ag­gres­sive hy­brid fund (note that the name ‘bal­anced’ gets dropped here) can have an eq­uity al­lo­ca­tion of 65-80%.

Four, scheme names were mis­lead­ing. For ex­am­ple, the MIP, which gave the im­pres­sion of giv­ing a guar­an­teed re­turn, will now be called a con­ser­va­tive hy­brid fund. The credit op­por­tu­ni­ties fund will now be called credit risk fund. The cat­e­gory was launched by fund houses to of­fer cor­po­rate bonds with less than triple A rat­ing—higher risk bonds in the bag meant pos­si­bil­ity of higher re­turns. For in­vestors who can take the risk of lower-grade pa­per, this is a great cat­e­gory, but the name seemed to in­di­cate only the up­side and not the risk. Debt as an as­set class is just be­gin­ning to be un­der­stood by re­tail in­vestors. It is the duty of the reg­u­la­tor to en­sure that in­vestors do not mis­un­der­stand the prod­uct and take on higher risk than they should be­cause of smart nomen­cla­ture.

There will now be 36 cat­e­gories of mu­tual fund schemes and as my col­league Kayezad E. Ada­ja­nia pointed out in this piece bit.ly/2gn­nu7j, there are too many debt fund cat­e­gories. But it is good that Sebi has taken the next step to stream­line the In­dian mu­tual fund in­dus­try fur­ther. Ten years of height­ened reg­u­la­tory ac­tion is re­sult­ing in eq­uity flows com­ing into the in­dus­try in an or­derly and sta­ble man­ner. This next piece of re­form should get the in­dus­try ready for fu­ture growth as in­vestors get a bet­ter han­dle on what they are buy­ing.

Dis­clo­sure: the au­thor serves on Sebi’s Mu­tual Fund Ad­vi­sory Com­mit­tee and was a mem­ber of the sub-com­mit­tee formed to con­struct the con­tours of the ra­tio­nal­i­sa­tion of schemes.

Monika Halan works in the area of con­sumer pro­tec­tion in fi­nance. She is con­sult­ing edi­tor Mint and on the board of FPSB In­dia. She can be reached at monika.h@livemint.com.

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