Monday, March 26, 2012

March 2012

The AUM of equity schemes increased by 3% to Rs. 1.61 lakh crore in February 2012 from Rs. 1.56 lakh crore in January 2012 ably assisted by a 3% spurt in BSE Sensex in February 2012. Equity mutual funds suffered a second consecutive net outflow in February 2012 to the tune of Rs. 2680 crore as against Rs. 456 crore in January 2012 according to the latest AMFI data. Sales from all equity schemes stood at Rs. 3,607 crore, the highest since September 2011 while redemption stood much higher at Rs. 6,287 crore, the highest since October 2010, which resulted in Rs. 2,680 crore net outflows. But for liquid, gold ETFs and fund of funds investing overseas, all other categories recorded net outflows to the tune of Rs. 5707 crore. The total assets under management of the industry went marginally up by 2% from Rs. 6.59 lakh crore in January 2012 to Rs. 6.75 lakh crore in February 2012. In the last 11 months equity mutual funds have seen a net inflow of just Rs 51 crore which is better than last year. For the 11 months last year, equity mutual funds suffered an outflow of Rs 13,591 crore. Despite the huge outflows, sales were much better in the previous period which came up to a total of Rs 61,225 crore compared to the sales of the last 11 months which amounted to just Rs 45,635 crore.

According to the latest statistics from the Securities and Exchange Board of India, as many as 514,000 equity folios were closed, further reducing the retail investors’ base for the struggling mutual fund industry. Taking the latest exodus into account, the financial year 2011-12 has so far seen the closure of 1.4 million equity folios. In 2010-11, the industry had lost 1.8 million equity folios. SIP inflows have declined in December 2011 and January 2012. This trend can be attributed to investors switching their investments to tax-free products with the financial year-end closing in and to the loss of confidence among investors in the market due to the prevailing volatility. According to a leading registrar, new SIP registrations for the month of December 2011 stood at 1.51 lakh, which dropped to 95,272 in January 2012. A lot of investment has moved from SIPs into tax-free products, where the investors are earning 11% returns. They do not want to take risks in equity because they currently lack the confidence in the market. Investors need to understand that SIPs win in the long run.

Piquant Parade

HDFC Asset Management Co. Ltd, and Pramerica Asset Managers Pvt. Ltd, an arm of the US-headquartered Prudential Financial Inc, have emerged as the frontrunners to buy the assets of Fidelity’s mutual fund in India—FIL Fund Management Pvt. Ltd. Out of some 20 bidders, HDFC and Pramerica mutual funds have been shortlisted and their bids are in the range of Rs. 400-500 crore. HDFC and Pramerica’s bids value Fidelity Mutual Fund at 4-5% of its average assets, a sizable amount in light of the AMC’s cumulative losses of Rs. 333 crore. In 2011, its losses more than doubled to Rs. 62.39 crore over the previous year. An interesting income-tax provision plays a key role behind the ongoing Fidelity deal. In normal course, under section 72 of the Income-Tax Act, a mutual fund is allowed to carry forward its losses for eight years. But, under section 79 of the law, this loss is not allowed to be carried forward if there is a change in ownership of the company. If a fund house directly buys the assets of Fidelity MF in India, section 79 of the income-tax law will be triggered and the buyer will have to bear the losses of Fidelity Mutual Fund at one go. This can be avoided through another clause of section 79, which allows losses to be carried forward, post the deal, only if the Indian company is a subsidiary of a foreign company and the change in ownership arises as a result of amalgamation or demerger of the foreign company. The acquirer will not only be able to carry forward the losses of Fidelity Mutual Fund for eight years but also save on taxes till such time its profit gets offset by past losses. For this reason, the bidders are willing to pay a little more than average valuations for an acquisition. Fund house acquisitions are valued on the basis of the asset mix, network strength, long-term earnings prospects and profitability.

Schroders, the UK-based asset management giant that manages close to $291 billion in assets, is set to acquire nearly 30% in Axis Asset Management Company. The transaction will help Schroders revive its India presence and end Axis Asset Management Company’s search for a strategic partner in the mutual fund business. While two other companies had evinced interest in buying a stake in the asset management company promoted by Axis Bank, Schroders is set to seal the deal.

Regulatory Rigmarole

SEBI, the capital market regulator, has announced a change in the advertising code for mutual funds from being ‘rule-based' to ‘principle-based'. Mutual funds will now be required to make fewer disclosures. One of the biggest challenges that fund houses faced earlier was in the disclosure of the risk factors. While the advertisement itself was just four lines long, the risk factors alone would run for 15-20 lines. Under the new regulation, the risk factors would occupy around 40% less of the surface area in case of print ads, and lead to a significant reduction in advertising expenditure. SEBI now mandates that these risk factors will now be replaced by the disclaimer — “Mutual funds are subject to market risk. Please read the scheme-related offer documents carefully.” SEBI has also asked fund houses not to mention fund ratings due to lack of uniformity in awarding these rankings. Only those funds, like the capital protection funds, which require SEBI-mandated ratings, are allowed to mention their ratings in the advertisements. With respect to the audio-visual advertisements, the new regulation re-emphasises the need to be audible and understandable to the viewers or listeners. However, confusion still persists over certain issues. The new regulation forbids the use of ‘slogans' in advertisements. The definition of ‘slogan' remains unclear though.

The National Stock Exchange (NSE) has launched a know-your-customer registration agency (KRA) through its subsidiary Dotex International. The move comes in the wake of specific directive from the Securities and Exchange Board of India to start KRAs. The initiative by SEBI will benefit investors, as their paper work will be reduced and they have the option of going to another intermediary, without repeating the know your customer (KYC) formalities. An investor will not have to repeat the KYC, if he has done it through either a broker or a depository participant, or with an asset management company, to invest in a mutual fund.

SEBI has relaxed the portfolio replication from 100% to 70% in PMS or advisory funds for domestic fund managers. The move spells good news for AMCs managing offshore funds or PMS in India. SEBI has stated that a minimum of 70% of portfolio value shall be adequate, provided that the AMC has in place a written policy for trade allocation and it ensures that the fund manager does not take directionally opposite positions in the schemes managed by him. Instead of two fund managers managing offshore funds, AMCs can have one fund manager running the show. Earlier AMCs were required to have different processes, systems and fund managers for managing offshore funds.

SEBI has clarified that the responsibility of distributors due diligence rests solely with AMCs. It has asked AMCs not to delegate this responsibility to any agency. AMCs can take the help of external auditors to conduct due diligence but the final responsibility rests with AMCs. A majority of the AMCs have agreed with AMFI for appointing common audit firms to kick start distributor due diligence. Meanwhile, AMFI is trying to convince the three remaining AMCs to come on board as well. The cost of the project will be shared among all the AMCs depending on the number of distributors empanelled with a fund house. SEBI’s circular states that the audit should ascertain distributors servicing standards, grievance redressal mechanism, experience, staff training and certification among other things. The due diligence, a part of SEBI’s first step towards regulating mutual fund distributors, will cover the big distributors accounting for a substantial chunk of the industry AUM.

SEBI has given seven months to AMCs to implement the new valuation norms for liquid funds. Under this, the regulator has decided to bring down the threshold for marked to market (MTM) requirements to 60 days from 91 days earlier. The new norms will be effective from September 30 2012.To enhance transparency, AMCs should disclose all details of debt and money market securities transacted in its schemes portfolio on their websites. Fund houses are required to make these disclosures daily with a time lag of 30 days.

The country's mutual fund industry is battling a Rs 500-crore tax demand on interest earnings from some of their earlier investments in securitised papers. In order to pre-empt tax authorities from freezing their bank accounts, fund houses have moved court challenging the order. Leading mutual funds including UTI MF, SBI Mutual Fund, HSBC AMC, Birla Sun Life MF, Reliance Mutual Fund, Religare and Kotak have filed writ petitions, praying for a stay, before the Bombay High Court. Even though mutual funds are exempt from paying tax on their income from investments, the Income tax Department believes that income from securitised instruments, better known as pass through certificates (PTCs) in financial markets, are taxable. The tax claims pertain to assessment years 2007-08, '08-'09 and '09-'10.

The 2012-2013 Budget certainly lacked any big bang wealth creating opportunity as far as the stock markets are concerned. But it did try to do its bit to enhance the depth of the market and pump in more liquidity into the same. Introduced for the first time ever, the Rajiv Gandhi Equity Savings scheme allows for income tax deduction of 50% to new retail investors (approximately 1.5 crore investors). However, the investment is subject to a maximum limit of Rs 50,000 and restricted to investors with annual income of less than Rs 10 lakh. Besides, the scheme also has a lock-in period of 3 years. This move is certainly a precursor to the proposed Direct Taxes Code. To provide a safer environment, investments under the new scheme may initially be allowed only in the top 100 or 200 companies (on the basis of market capitalisation) listed on various stock exchanges. The new scheme is being designed to encourage flow of savings in financial instruments and improve depth of the domestic capital market. The Securities Transaction Tax (STT) on cash delivery transactions has been reduced by 20%, from 0.125% to 0.1%, in order to reduce transaction costs in the capital markets. The budget announced a hike in service tax from 10% to 12%. Fund houses pay a service tax on the assets managed by them, which they used to set off against the service tax paid on distributor commissions. However, with the recent exemption in service tax on distributor commissions they have little leeway to set off such costs.

53% of actively managed equity funds have failed to beat S&P CNX Nifty, a benchmark index for large cap companies according to a CRISIL study. However, in 2011, 65% large cap funds produced higher returns than the S&P CNX Nifty. Similarly about 58% of diversified funds underperformed the S&P CNX 500 over the past five years but in 2011, 54% of diversified funds were able to beat the index. The story is similar for ELSS and balanced funds. MIPs, gilt and debt funds (which invest in corporate debt) on the other hand have outperformed their benchmarks over a five year period. The Indian mutual fund industry is going through a consolidation phase. None of the categories had a 100% survivorship over the past five years indicating mergers across categories. Among funds, diversified equity funds had the lowest survivorship in the one and five-year periods, while balanced funds had the lowest survivorship in the three year period.

Monday, March 19, 2012

March 2012

Tough times ahead for NFOs…

SEBI has proposed that, a Mutual Fund New Fund Offer (NFO) will be approved only if it is able to attract a minimum level of investor interest. To be specific, it will be approved only if a certain amount of minimum corpus is invested in it by the public - Rs. 10 crores for equity funds and Rs. 20 crores for debt funds. If there is low investor interest and there are not many buyers, the NFO will be scrapped. This will make the lives of fledgling and small mutual fund houses difficult because, until they can establish themselves in the Indian mutual fund industry, they will not be able to attract investor money. Unfortunately, in this case, unless they attract at least Rs.10 crores for equity funds (Rs.20 crores for debt funds) their mutual fund will not even be approved. So, it is like a double-edged sword for the mutual fund houses. If the new fund is not able to attract enough funds (Rs 10 or 20 crores as the case may be), then the fund has to be closed and the money invested by the investors has to be returned in the next 15 – 20 days. SEBI has also stated that, if the refund fails to happen within the next 6 weeks (from date of closure), the fund house is supposed to pay an interest of 15% to the investors.

DSPBR Dual Advantage Fund – Series 2
Opens: March 12, 2012
Closes: March 20, 2012

DSP Black Rock Dual Advantage Fund - Series 2 is a 36 month close-ended income scheme. The primary investment objective of the scheme is to generate returns and seek capital appreciation by investing in a portfolio of debt and money market securities. The scheme also seeks to invest a portion of the portfolio in equity & equity related securities to achieve capital appreciation. As far as investments in debt and money market securities are concerned, the scheme will invest only in securities, which mature on or before the date of maturity of the scheme. The fund would allocate 50% to 100% of assets in debt securities, up to 25% of assets in money market securities and up to 25% of assets in equity & equity related securities. Debt securities may include securitized debt instruments up to 50% of the net assets. The fund will be managed by Mr. Dhawal Dalal.

DWS Interval Fund – Series 3
Opens: March 13, 2012
Closes: March 20, 2012

Deutsche Mutual Fund launched a new debt interval scheme named DWS Interval Fund – Series 3, with a maturity time of 93 days. The objective of the scheme is to generate income by investing in debt and money market instruments maturing on or before the beginning of the immediately following Specified Transaction period of the Scheme. The asset allocation of scheme will be in such a way that the objective of the scheme to generate income will be met, through investments in debt and money market instruments. Hence, the scheme will allocate 0 to 100% of assets in domestic debt instruments including government securities and money market instruments. The performance of the scheme will be standardized against CRISIL Liquid Fund index and Kumaresh Ramkrishnan will be the Fund Manager of the scheme.

Axis Income Fund
Opens: March 9, 2012
Closes: March 21, 2012

Axis Mutual Fund launched a new open-ended income fund called “Axis Income Fund”. The scheme will endeavour to generate optimal returns in the medium term while maintaining liquidity of the portfolio by investing in debt and money market instruments. The scheme will allocate up to 100% of assets in debt and money market instruments with low to medium risk profile. The performance of the scheme will be standardized against CRISIL Composite Bond Fund Index and R. Sivakumar and Mr. Ninad Deshpande will be the Fund Managers for the scheme.

Birla Sunlife Capital Protection-oriented Fund– Series 9
Opens: March 12, 2012
Closes: March 26, 2012

Birla Sun Life Mutual Fund has launched a new fund named as Birla Sun Life Capital Protection Oriented Fund – Series 9, a close-ended capital protection oriented scheme. The investment objective of the scheme is to seek capital protection by investing in fixed income securities maturing on or before the tenure of the scheme and seeking capital appreciation by investing in equity and equity related instruments. The performance of the scheme will be benchmarked against CRISIL MIP Blended Index and will be managed by Mr. Satyabrata Mohanty.

ICICI Prudential Capital Protection-oriented Fund II – Series 8
Opens: March 16, 2012
Closes: March 26, 2012

ICICI Prudential Capital Protection Oriented Fund – II –Series 8 (24 Months Plan) is a close-ended Capital Protection Oriented Fund. The objective of investment in the Fund is to try to protect capital by investing a portion of the portfolio in good quality debt securities and money market instruments (88%–100%) and also to provide capital appreciation by investing the balance in equity and equity related securities (0% – 12%). The performance of the fund will be benchmarked against CRISIL MIP Blended Index. Chaitanya Pande and Rajat Chandak will be the fund manager(s) of the fund. The former will take care of debt investment and the latter of equity investment.

Reliance US Dollar Fund, IDFC Balanced Fund, SBI Hybrid Edge Fund, SBI Sensex ETF Fund, DSPBR US Flexible Equity Fund, IDFC Infrastructure Debt Fund, IDBI Infrastructure Debt Fund, India Bulls Income Fund, and IDFC Bank CD Fund are expected to be launched in the coming months.

Monday, March 12, 2012

March 2012

Arbitrage opportunities widen during volatile times and arbitrage funds give better returns and work well only if spreads are significant. As these funds resort to heavy trading to maximise gains, expense ratios are higher. Moreover, investors would neither be able to predict the gains nor how they would perform over a longer period. With gains from fixed maturity plans well over 9% for investments of little over a year, arbitrage funds may not be attractive for the one-year time frame.

Inspite of the temporary lull in the performance of arbitrage funds, all the GEMs in the March 2011 GEMGAZE have retained their preeminent position in the March 2012 GEMGAZE, thanks to their consistency and stability.

Shining star

UTI SPREAD Fund is a six-year old five star fund with an AUM of a paltry Rs. 34 crore. Its one-year return of 8.61% is ahead of its category average of 7.61%. 61% of the portfolio is in equities, with finance, diversified and services being the top three sectors. The entire assets allocated to equity are in 61stocks. 14% of the assets are in debt with 25% in cash. The increase in allocation to equity compared to last year can partially explain the tremendous improvement in one-year return. 58% of the portfolio is in large caps and 41.78% of the portfolio is in the top three sectors. While the portfolio turnover ratio is a massive 870.1%, the expense ratio is very low at 1%.

HDFC Arbitrage Fund Gem
Consistent resilience

In its four-year old existence, HDFC Arbitrage Fund has been able to reach an AUM of a mere Rs 51.76 crore. The one-year return of the fund is 7.59% as against the category average of 7.61%. There has been a sea change in the sector preference of this fund. The healthcare sector has occupied the top slot toppling energy sector to the fifth position. The sectors that come second and third in preference are FMCG and services. Top 5 holdings constitute 33.67% of the portfolio. Equities constitute 68% of the portfolio with 55% in large cap stocks. The portfolio has 30 stocks and the portfolio turnover ratio is high at 157.66%. The expense ratio is as low as 0.85%.

Kotak Equity Arbitrage Fund Gem
Astute player

Incorporated in September 2005, Kotak Equity Arbitrage Fund has an AUM of Rs 125.61 crore. The one-year return of the fund is 8% as against the category average of 7.61%. Top five holdings constitute 27.25% of the portfolio, with the equity exposure continuing to be nil and debt constituting 27% of the portfolio. The portfolio turnover ratio is 166.85% and the expense ratio is 0.95%.

JM Arbitrage Advantage Fund Gem
Cost advantage

The Rs 42.37 crore JM Arbitrage Fund, incorporated in 2006, has earned a 1-year return of 7.99% beating the category average return of 7.61%. Top five holdings constitute 41.5% of the portfolio with communication, energy, and metals forming the top three sectors. Equity constitutes 69.68% of the portfolio with 73% in mid and small cap stocks. There are 19 stocks in the portfolio. The portfolio turnover ratio is very low at 10.31%. The expense ratio is 1%.

SBI Arbitrage Opportunities Fund Gem
Expensive proposition

SBI Arbitrage Opportunities Fund, incorporated in October 2006, has an AUM of Rs 74.93 crore. Its one-year return is 8.39 %, well ahead of the category average return of 7.61%. The top five holdings constitute 34.48% of the portfolio. Metals, energy and textiles are the top three sectors. 69% of the portfolio is made up of equity with 58% in large cap stocks. There are 43 stocks in the portfolio with a very high portfolio turnover ratio of 874%. The expense ratio is very high at 1.84%.

Monday, March 05, 2012

March 2012

High returns at low risk

Want high returns at low risk? Try arbitrage funds. These funds try to cash in on the price variation of the same security in different markets; they go long in the cash market, short in the futures market and behave like a debt fund. Theoretically, these funds benefit from the arbitrage opportunities arising out of price differences between the equity and derivatives segment of the stock market. But this does not ensure returns. The real attraction of arbitrage funds is in post-tax returns. How do they work? Suppose a stock is trading in the cash market at Rs 400 whereas in the futures market its price is Rs 410. An arbitrage fund will buy the stock in the cash market and simultaneously sell it in the futures market, locking a gain of Rs10. On the settlement day, it will reverse the transaction. If the price of the stock goes down, so will the price of the futures. No matter what the price of the stock, the fund will make a profit of Rs 10 per share. On the date of expiry, when the arbitrage is to be unwound, the stock price and its futures contract of the current month coincide. Arbitrage funds appear to be one of the best options in a volatile market for investors who wish to invest in a low-risk portfolio and yet earn decent returns.

The cutting edge

Arbitrage funds enjoy an edge over debt funds mainly because of the tax benefit. No tax on the gains of arbitrage funds in the long term (one year or more) and only 15% tax in short term (less than a year). The mandatory 65% in equity needs to be maintained by the fund manager. Otherwise, they would not qualify for the equity tax benefits. Assuming that returns from arbitrage funds are the same as debt funds or even if arbitrage funds offer a slightly lower return, the tax advantage gives arbitrage funds a significant edge over their debt fund counterparts.

Arbitrage strategy reduces risk and delivers decent risk-adjusted returns in comparison to other short-term debt funds, even in times of market volatility.

The ‘hidden’ risks

Arbitrage funds depend heavily on the availability of arbitrage opportunities in the market. Lack of such opportunities can sometimes dampen the results.

Sometimes, when the futures contract expires, the price of the stock in the cash and futures segments can have a slight difference in their prices. As a result, profit will be affected.

Each transaction in the stock market involves payment of brokerage and security transaction tax (STT). These costs can chop some of the earnings of the fund.

Crushed by competition?

The total average assets under management (AAUM) of 15 arbitrage funds in India dropped to Rs 955 crore as of December 31, 2010, from Rs 4,105 crore as of April 31, 2010 according to data provided by Value Research. The key reason (behind the sharp drop in assets of arbitrage funds) is the lack of arbitrage opportunities, given the increased volume in derivatives, especially options, and also higher returns by liquid funds in the last few months. The arbitrage fund category has returned almost 6% in 2010 and roughly 4.5% in 2009 as against 8-9% by fixed maturity plans (FMPs) and 8.5% by liquid schemes. Between 2006 and 2008, this category fetched average returns of 7-8% with the better performers aiming at 10-11%, higher than returns from money market products. In addition to higher returns, the better tax treatment of arbitrage schemes compared to fixed income also lured investors to this product in the past. Arbitrage schemes of domestic mutual funds have fallen out of investors' favour in the past 18 months. Assets under this category have fallen 82% since January 2010 to Rs 300 crore as dwindling arbitrage opportunities and the higher yield on fixed maturity plans (FMPs) and liquid funds have squeezed returns in the past two years, prompting investors to shift money to short-term debt or money market products. Tax advantage is getting eroded in a situation of rising inflation and high bank interest rates. An average return of 6% (tax-free) from arbitrage funds is not better than the fully taxed, but fixed and safe return of 9% offered by banks currently. But this is likely to be a temporary phenomenon.

Making volatility work

An investor can consider including these funds in his core portfolio anytime without worrying about where the markets are heading. While the equity investments can pull the overall portfolio returns, arbitrage funds tend to bring a sense of steadiness to them. The returns generated by arbitrage funds are not too high but the ‘risk-free’ nature is their ‘high point’. The ideal time horizon for investing in these funds is one year or more to avail the tax advantage. Whether the markets zoom ahead or fall backwards, they will always continue to surprise us, as ‘capricious’ is its inherent nature. Why not then, ‘ride on volatility’ with arbitrage funds and make volatility work by gaining from the opportunities lying in the different moods of the market?