Monday, October 29, 2007

Fund Fulcrum (contd.)
(October 2007)
Piquant parade (contd.)

US-based financial major, Goldman Sachs, is to establish an asset management company in India, with an initial investment of $ 50 million. Of the proposed $50 million, $7.5 million will be invested upfront and the remaining $42.5 million will be invested in the next 2 years.

Union Bank is planning to enter the mutual fund industry accompanied by a foreign company as its partner by the end of this fiscal.

Regulatory Rigmarole

The Securities and Exchange Board of India is looking at reducing the fees of all mutual fund schemes — equity funds (open- and close-ended), debt funds, index funds and even funds of funds. The first step in this exercise was Sebi’s proposal in August to scrap the entry-load payment on open-ended schemes that are bought through online applications or directly through asset management company collection centres instead of distributors.

This proposal by SEBI has faced opposition from the Financial Planning Standards Board (FPSB) India, a Mumbai-based professional standards-setting body for financial planners. As a first option, the Board has recommended that the rebating system should be reinstated for mutual fund distributors, but the discount given to investors should be properly documented. Under the rebating system, which was eliminated by Sebi in June 2002, distributors can give a certain percentage of discount to customers out of their commission income. The second option is a 'variable entry load' model at investor level under which a client and distributor can negotiate entry load on a transaction-to-transaction basis, based on the perceived value of advice. As per the present guidelines, variable loads are allowed at a scheme level. The proposed model, which is similar to the structure prevalent in the stock-broking industry, allows distributors to add value to its services to clients, without impacting the NAV. Currently, an investor hands over an amount to a distributor who gives it to the fund house. The fund house deducts the entry load from the amount and gives it to the distributor, who unofficially parts with a small portion of this money to the investor, thereby, denying the investor the entire benefits of the investment. In the proposed variable fee-based structure, the client pays the distributor a certain fee for the advice, over and above the investment amount. A third option suggested is a two-track system for charging loads marked by two options. One, a zero-entry load option carrying a higher exit load or, two, an entry load with no exit load.This will enable fund houses to retain an investor for a longer period of time.

In a bid to bring transparency in the manner in which mutual Funds charge expenses to closed-ended schemes, Sebi is likely to prohibit close-ended Mutual Funds from charging up to 6% of the corpus as initial offer expenses, which is then amortised over a period of time. Amortisation allows AMCs to show a higher NAV in close-ended schemes. For example, if you buy 100 units of Rs 10 each of a new close-ended fund, the fund house charges 6% as initial expenses, which means that the NAV should be Rs 9.40, but it is still shown as Rs 10 initially. The Rs 6 charged to the scheme is amortised over a period. In April 2006, Sebi had recast regulations relating to initial issue expenses and banned only open-ended schemes from charging 6% initial issue expenses. The open-ended schemes had to meet sales, marketing and other expenses through entry load (not allowed in the case of close-ended schemes), which is usually about 2.25%, and not initial issue expenses. The difference in treatment of expenses between open and close-ended schemes has made the latter attractive for fund houses.

The RBI has hiked the overall limit for overseas investments by mutual funds from $4 billion to $5 billion. The cap on overseas investments by individual mutual fund houses has been raised to $300 million from the earlier limit of $200 million or 8-10 per cent of the total assets under management, whichever was lower. In addition, the existing facility of investing up to $1 billon in overseas Exchange Traded Funds, as may be permitted by SEBI by a limited number of qualified Indian mutual funds would continue. This is subject to a maximum of $ 50 million per mutual fund. The requirement of 10 years of experience of investing in foreign securities for being eligible to invest in overseas Exchange Traded Funds (ETFs) has been dispensed with. Moreover, Indian mutual funds are now allowed to invest in a new basket of instruments overseas that include ADRs/GDRs issued by foreign companies, initial and follow-on public offerings, foreign debt securities in the countries with fully convertible currencies, which have a rating not below investment grade, and also money market instruments that are rated not below investment grade. Mutual fund can also invest in government securities of countries, which are rated not below investment grade. Other instruments include derivatives traded on recognised stock exchanges overseas only for hedging and portfolio balancing with underlying securities, short-term deposits with banks overseas where the issuer is rated not below investment grade, units/securities issued by overseas mutual funds registered with overseas regulators and investing in approved securities of Real Estate Investment Trusts listed in recognised stock exchanges overseas or unlisted overseas securities which are less than 10 per cent of their net assets.

Since mid-September, the pace of FII money in the form of Promissory Notes (PNs) flowing into the Indian bourses has been unprecedented leading to a bubble-like growth in stock prices and a steroid effect on the Indian Rupee. With FIIs dealing with PNs having been asked to register themselves with SEBI, the veil of threat shrouding the identity of those investing in the Indian stock markets have been done away with. The markets have since stabilized and the positive outlook is inviting many foreign funds to seek greener pastures in India.

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