Monday, May 31, 2010

FUND FULCRUM (contd.)
May 2010

Piquant parade

Private sector mutual fund, Axis Mutual Fund, is aiming at more than doubling the size of assets under its management to Rs 10,000 crore and investor base to 30 lakhs by March 2011 and is looking at entering the overseas markets in 2012. Axis Mutual Fund currently has a distribution centre in Dubai. Axis, which got SEBI approval for mutual fund business in September, 2009, currently has an AUM of around Rs 4,000 crore. The fund currently has an equity base of Rs 75 crore, which could be raised to about Rs 125 crore in two years. Axis Mutual Fund is looking at becoming one of the top 10 players in the next 4-5 years. By then, the mutual fund industry is expected to grow over three-fold to about Rs 25 lakh crore.

An MOU was signed between Birla Sun Life Mutual Fund and Oriental Bank of Commerce for a strategic alliance to distribute and market mutual fund products through branches of Oriental Bank of Commerce. The bank is committed to become a financial supermarket that provides diverse financial products under one roof to its customers.

Regulatory Rigmarole

Association of Mutual Funds in India (AMFI) has announced that distributors will not get trail commission in case the investor transfers his mutual fund account. The unpaid trail commission will be put in an investor education fund. Asset Management Company pays trail commission to the distributor if the investor stays with a mutual fund scheme. Securities and Exchange Board of India (SEBI) had earlier allowed investors to change distributors without No Objection Certificate from the current distributor; this had led to a sharp rise in the transfer of accounts. As per the new guideline, AMC will not pay trail commission to either the old or the new distributor if the mutual fund account is transferred.

The Securities and Exchange Board of India has directed asset management companies to disclose investor complaints. Investor complaints will have to be disclosed on websites and annual reports. AMCs will have to upload 2009-10 data by June 30, 2010. Going forward, they will have to disclose details after two months of the closure of the financial year.

Self-styled distributors, lacking basic qualifications to sell mutual fund units, are advising investors as to where they should put their hard-earned money. Distributors need to pass the AMFI Advisors’ Module if they want to sell mutual fund schemes to investors. Top national distributors, who sell investment products across asset classes, are not insisting on AMFI certification while appointing sub-brokers (sub-advisors or franchisees). This is more prevalent in franchisees or sub-broker offices in tier-II and tier-III cities. Top distributors simply ask for a small membership fee at the time of empanelling as a sub-broker. They are not really concerned about AMFI registration or any certification. These distributors are allowed to sell products across asset classes, from equity mutual funds to ULIPs, corporate deposits and even Nabard bonds on certain occasions. While fund houses are aware of this trend, they are not really worried about it. According to them, AMFI advisors’ module syllabus is outdated —the syllabus was last updated in mid-2006 — and could be slightly out of context, considering the large number of changes effected to the mutual fund industry post-2008.

In a month’s time, short-term debt mutual funds, which make up an overwhelming proportion of the Indian mutual fund industry, will undergo a fundamental change. These products are the staple of corporate investments that are made in mutual funds. They are the most popular asset class into which Indian CFOs park short-term cash in order to generate safe and predictable returns. The predictability of the returns is a key reason as to why these products are used. However, under the new valuation rules that SEBI has implemented, these funds are going to be a lot less predictable from July 1, 2010. The reason for this change is that the daily valuation of these funds are going to be done on the basis of the market price of their investments, rather than a straight-line value calculated from their coupon rate, as has been the practice so far. Investors can invest in them even for the shortest periods and know precisely how much they can expect the NAV to be each day in the future. Moreover, unlike bank deposits, it has so far been practical to make and redeem investments in these funds even for extremely short periods like two or three days. Now, all this is set to change.

Around Rs 120-150 crore of distributor commission is yet to be released by fund houses, citing non-compliance with the latest SEBI rules on know-your-client (KYC). Foreign banks, which are among the largest mutual fund distributors, have been hit the hardest. That is because these banks, which follow a calendar accounting year, have already factored in the earnings from mutual fund distribution in their international balance sheet. They will now either have to provide for this amount, or declare it as disputed income in their audited results. Most of the Indian private sector banks have not accounted for it last year (financial year 2009-10). They still have some time to account for it. However, the foreign banks have a different reporting system. After domestic private sector banks, foreign banks are the largest distributors of mutual fund products in the country. These include Citi, HSBC, Standard Chartered Bank, Deutsche Bank, BoA Merrill Lynch, ABN Amro (now RBS) among others.

Market regulator SEBI released panel report by various industry subgroups recommending changes to the eligibility and networth criteria for market intermediaries. It has recommended that the net worth for asset management companies should be increased to Rs 50 crore over a period of three years in a phased manner from the current limit of Rs 10 crore. Increasing the net worth requirement will not do anything tangible to increase investor safety. However, it will definitely increase entry barriers in a field that needs more competition. Moreover, monetary penalties should be imposed on AMCs who inadequately disclose their scheme holdings.

SEBI is preparing ground for a fresh set of mutual fund reforms to make the instrument more transparent and attractive for investors. The Mutual Fund Advisory Committee, comprising industry and SEBI representatives want fund houses to keep promotional expenses, such as those on foreign trips and gifts to distributors, outside the ambit of the expense ratio. This ratio — it includes fees paid to fund managers, advertising, legal, record-keeping and accounting costs, custodial charges and taxes — is capped at six per cent for a scheme. In most cases, fund houses keep the expense ratio around 2.5 per cent, but include promotional costs in the calculation. The regulator suspected that many costs passed off as advertising or promotional expenses were in reality paid to distributors for pushing sales.

The regulator would want to put in place a more investor-friendly performance review mechanism. At present, apart from the daily net asset value, fund houses put out monthly fact-sheets which provide mathematical calculations comparing and evaluating the schemes on offer. The regulator feels retail investors find this form of review complicated. Instead, it wants mutual funds to provide specific quantitative parameters for one to be able to judge the performance of a scheme.

The advisory committee is also to discuss issues like guidelines for mutual fund investments in equity derivatives. This has become a contentious issue. Some members feel fund houses should not be allowed to invest in risky instruments like stock derivatives. However, if a complete ban was not possible, there should be some specific guidelines.

The committee was also likely to look at the issue of conflict of interest among trustees, asset management companies, and managements of fund houses. SEBI had addressed the issue by ordering that AMCs, trustees, and managements should have different sets of individuals.

The continuous stream flowing out of the regulator's kitty bears testimony to the fact that the regulator wants to ensure that no gaps remained in the regulations.

It is vacation time! In the ensuing three months, FUND FULCRUM alone will appear in the last Monday of each month. The regular features will blossom once again from September 2010 onwards.

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