FUND FULCRUM (contd.)

April 2012

Lacklustre equity markets, coupled with low distributor support and abundance of high-yield debt instruments, are prompting investors to redeem their money from mutual funds. Folios of retail investors in debt funds have gone up by 5.71 lakh in the previous fiscal. The industry saw Rs 8,770 crore dip in retail AUM from equity funds. Retail mutual fund investors have exited equity funds in hordes. They have rushed to debt funds for safer returns. The latest data released by AMFI shows that as many as 15.76 lakh retail equity folios were closed in FY 2012. Overall, there were 3.92 crore equity folios in March 2011; the number is now 3.76 crore folios in March 2012, a decline of 16.40 lakh folios. Close to 96% of the drop in folios was due to exit of retail investors. Equity funds saw total erosion of Rs 15,160 crore in AUM in FY12 and the retail segment accounted for 58% or Rs 8,770 crore. Overall, there were 7.82 lakh folio closures in FY 2012 from all fund categories. The industry had 4.72 crore folios in March 2011. This figure has dropped to 4.64 crore folios as on March 2012, a decline of 7.82 lakh folios. Industry experts are citing redemption from SIPs as the main reason for drop in equity folios. Retail investors seem to have taken a liking for debt funds. Retail debt folios have gone up to 45 lakh in March 2012 from 39.29 lakh folios last year, a spike of 5.71 lakh folios. Total debt folios went up to more than 50 lakh from 43 lakh in 2011, registering an increase of 7.14 lakh folios. 80% of this spurt was due to retail investors.

Piquant Parade

Leading private sector lender Axis Bank inked an agreement with Schroder Singapore Holdings, a wholly owned subsidiary of global AMC major Schroders, to sell 25% share of Axis Asset Management Company, the bank's mutual fund arm. The transaction is subject to regulatory approval and is expected to materialize during 2012. It provides Axis AMC access to Schroders’ global distribution network and to advise overseas funds invested in Indian Securities.

Small and mid-sized mutual fund houses have raised questions at the functioning of their industry body - Association of Mutual Funds in India (AMFI). Though the smaller players have been unhappy with AMFI for quite some time, the latest trigger for their angst is the industry body’s plan to stop payment of upfront commissions to distributors selling equity products. Though there have been improvements, they continue to feel neglected as their concerns are not heard. The bigger peers always tend to control decisions at the AMFI board. AMFI is a Section 25 company, run by a board of directors, comprising 15 members, elected from the largest to the smallest fund houses, giving proportional representation to all. Two years back AMFI had less than 10 members on its board. Following suggestions from small fund houses, the number of members was increased, thereby giving participation to the smaller players, too. AMFI, the apex body of all the registered AMCs, was incorporated in August 1995, as a non-profit organisation. As of now, all the 44 AMCs registered with the Securities and Exchange Board of India, are its members.

Some of the leading Mumbai-based IFAs have come together to form a pan-India, not-for-profit body called the Foundation of Independent Financial Advisors (FIFA). Besides educating IFAs, the entity will take up the views of distributors with policymakers and regulators to facilitate the development of balanced regulations governing distribution of financial products and investment advice. FIFA will help its members understand the implications of new regulations and help them to adapt to the new rules. FIFA has also made suggestions to both SEBI and AMFI in connection with recent distributor regulations. The foundation will aim to enrol IFAs across the country. The entity will encourage regional associations and local bodies of IFAs to become members of FIFA. The foundation has submitted a detailed response to SEBI on the concept paper issued by the market regulator.

Regulatory Rigmarole

AMFI is lobbying with the finance ministry to secure an exclusive mandate to implement the Rajiv Gandhi Equity Scheme (RGES), a tax-efficient investment plan for retail investors that was introduced in the Union Budget. A permission to allow the domestic mutual funds to handle the proposed equity scheme will help the industry replace its existing tax-saver product - equity-linked savings scheme - which will lose its tax-saver status under DTC regime. Making direct stock investments is fraught with risk for first-time investors. Mutual funds will be a better vehicle for them to take exposure to stock markets. RGES, which is aimed at increasing retail participation in stock markets, offers an income tax deduction of 50% for investments up to 50,000 by new retail investors whose annual income is below 10 lakh. The government is considering reduction in the lock-in period in RGES from three years to one. The demand for RGES comes at a time when the mutual fund industry is passing through its roughest patches. If RGES is routed through funds, it will give a new reason to approach smaller investors. This scheme has the potential to draw large investments. About 15 lakh youngsters are added to the 1-10 lakh bracket every year.

Mutual fund distributors plan to approach SEBI for clarifying KYC rule, which requires in-person verification (IPV), which came into effect from January 1, 2012. Distributors, especially those who wish to enroll outstation or NRI clients, are facing hurdles in IPV. SEBI has allowed depository participants to verify their clients through a web camera. The AMFI committee on operations & compliance had discussed whether distributors could be allowed to use web cameras for verifying NRI clients. However, the committee did not arrive at a decision.

SEBI has directed intermediaries to upload KYC (know your client) details of existing clients to a centralised database maintained by KYC registration agencies (KRA). The timeline for uploading the KYC data would remove duplication in the process of collecting KYC details. All registered intermediaries — KYC registration agencies (KRAs), brokers through stock exchanges, depository participants (DPs) through depositories, mutual funds (MFs), portfolio managers (PMs), venture capital funds (VCFs), collective investment schemes (CIS), association of mutual funds in India (AMFI) have been directed to upload data according to the timeline and send original documents to KRAs latest by March 31, 2013.

Several fund houses have introduced exit loads on fixed income mutual fund schemes in April 2012. Fund houses such as SBI, Canara Robeco, Taurus, JP Morgan, Principal have introduced or increased exit loads on early exits by investors. The debt mutual fund schemes have been doing well for some time now. According to Value Research, an online tracking entity, short-term debt funds delivered 2.27% and income funds delivered 2.01% returns in the last three months. The exit load would discourage very short-term investments in these schemes as it brings down the net gain to investors. In case of large sums moving out of the fund in a very short period of time, fund manager has to sell liquid investments such as bank CDs, as privately placed bonds in most cases do not have an efficient secondary market. Frequent churning of portfolio pushes expenses of the schemes upwards. This in turn brings down the performance of the scheme. Exit loads introduced are in the range of 0.15% to 0.5% and are for redemptions before completing 15 days to 180 days depending on the scheme. An income fund may charge exit load for redemptions up to 180 days from the date of allotment of units, whereas a short-term bond fund, may charge exit load for redemption up to 90 days from the date of allotment.

Small mutual fund distributors and agents who rely on their certificates for doing business, will now have to shell out more than double the amount in order to keep the certificate, as the National Institute of Securities Market (NISM), and the Securities Exchange Board of India (SEBI) are making life tough for them. It costs, at the most, Rs 3,600 for adhering to the new mutual fund requirement norms stipulated by NISM at a time when the business is dwindling.

Back in August 2009, SEBI made a drastic regulatory change to the mutual fund business in India by banning entry load on fund investments. Now, two years later, the mutual fund industry has started speaking out clearly about the business impact of the change. Without the extra revenue from entry loads, distributors as well as many funds companies are finding business difficult. However, that does not mean that there is a case for simply restoring entry load in the same shape as it existed till July 2009. It must be remembered that at that time there was a valid context for SEBI’s action. Churning of investors’ fund holdings in order to earn commissions out of the entry load was a widespread abusive practice among some distributors, as was the NFO-and-dump cycle of investments. The heady days of 2004-2007 were basically one long party of endless NFOs and repeated churning of investments. Now that the dust has truly settled on those days, the entry load ban is not the only reason for the current listless state of the industry. The epicentre of any business is not the provider’s financial well-being but what is delivered to the customer. It is logical that the solution must come from the creation of a business model that explicitly links the economic interests of the distributor with the interest of the investors. For example, the interest of the investor lies in being recommended a good fund, starting a SIP in it and then sticking to it and the distributor’s interest is in a more substantial trail commission. In this regard, SEBI’s abolition of entry load missed a trick. The goal should have been the abolition of upfront commissions because of the churning-type abuses. What it did instead was to ban entry loads since commissions were paid out of the entry loads. However, the commissions are still paid but out of the AMC’s pocket. Basically, the pie has gotten smaller but its structure remains the same. From here on, the way forward would probably have to start with making the pie bigger. This could well be necessary for growth and expansion into new markets. Whether this is paid for by higher expenses or by higher exit loads is the question. However, it would make sense for all changes to be directly linked to the desired outcomes instead of hoping for the outcomes to be a sideeffect. For example, if expansion to smaller cities and first-time investors is a goal, then the AMC and the distributors must be able to derive a meaningful economic payback for delivering these outcomes. The fund industry’s starting viewpoint—that the entry load ban may have been counter-productive—is correct. But the solution does not lie in turning the clock back.