FUND FULCRUM (contd.)

November 2015

Mutual fund investments in stock markets have begun to cool in the past two months. After investing an average of Rs 8,200 crore each in the first six months of the financial year, mutual fund managers invested just an average of Rs 3,600 crore in October 2015 and November 2015. The drop in investment comes amid weakness in stock markets due to earnings disappointment and concerns around delay in reforms. In addition, gross redemptions from equity schemes have been on the rise, providing less leg-room for fund managers for fresh investment in stocks. In October 2015, fund managers invested less than Rs 3,000 crore, while so far this month they have bought (net of sales) shares worth around Rs 4,200 crore. Mutual fund investments are seen as a key support to the market at a time when foreign flows this year are on course to be the lowest in five years. So far this year, mutual funds have invested Rs 65,000 crore in Indian stocks. In comparison, foreign institutional investors (FIIs) have invested just Rs 21,351 crore during the same period. In 2014, FIIs had pumped in Rs 97,054 crore. The benchmark indices this year are down six per cent after a 30% rally last year. Till October 2015, the gross sales in the equity segment have surpassed Rs 1 lakh crore. However, at the same time what is worth noticing is the fact that gross redemptions too are about Rs 44,000 crore - a sizeable figure. New fund offers (NFOs) have considerably slowed down as well.

The National Securities Depository Ltd (NSDL) and the Central Depository Services Ltd (CDSL) allow investors to deposit securities by opening an account. The securities such as shares, debentures, bonds of investors are held in electronic form (dematerialised form) at the depositories. The two depositories, CDSL and NSDL, witnessed an addition of about 1.8 lakh investor accounts during September 2015. With 1.65 lakh more dematerialised (demat) accounts in October 2015, overall 17.35 lakh new investor accounts have now been opened in the past 12 months (till October 31, 2015), according to latest data available with the depositories and market regulator SEBI. At the end of October 2015, the total number of investor accounts at NSDL stood at nearly 1.42 crore, up from 1.41 crore registered till September-end this year. This implies an addition of 68,809 accounts in October 2015. CDSL reported 1.02 crore investor accounts till October-end this year, an addition of about 96,556 accounts in the month. According to information available with NSDL, an average of 3,589 accounts has been opened per day on the depository since November, 1996.

Regulatory Rigmarole

In a bid to expedite scheme mergers, SEBI has asked AMFI to prepare a report on schemes having similar fundamental attributes and persuade fund houses to merge such schemes. SEBI norms say that two schemes can be merged if the fundamental attributes of surviving scheme is not tinkered with. Fund houses are allowed to merge schemes keeping investors’ interests in mind. They have to get an approval by the board members and trustees. Fund houses then file a proposal with SEBI seeking such a merger. After getting an approval, AMCs give an exit option to investors. Typically, fund managers decide which schemes need to be merged. Usually, non-performing schemes or those which have a small AUM are merged with bigger funds. The shares held by the scheme which is getting merged are transferred to the surviving scheme. This results in increase in the number of units, AUM and the investor base of the surviving scheme. Despite the Budget 2015 having done away with tax liability on scheme mergers, the industry has not seen many scheme mergers so far. In addition, the government has reduced securities transaction tax (STT) from 0.25% to 0.001% in 2013. There could be a variety of reasons for this reluctance to merge schemes. A fund house may find it difficult to retain existing assets if schemes are merged. Secondly, fund houses have an incentive to charge higher expense ratio for small sized funds (scheme merger increases AUM). Finally, if AMCs have too many schemes, the probability of a few schemes doing well is high, which helps AMCs promote only the better performing schemes. Currently, the industry has close to 1,900 schemes. In fact, a few fund houses have three schemes each in the liquid fund and mid & small cap category. This creates confusion among distributors and investors.

Following the JP Morgan Mutual Fund’s decision to restrict redemption in two of its short term debt schemes due to Amtek Auto episode, SEBI is planning to come out with uniform guidelines on gating practices soon. The decision was taken at a recently held meeting of SEBI’s Mutual Fund Advisory Committee. Gating practices refer to the rights of fund houses to restrict investors from redeeming their investment from the fund if something went wrong with the scheme. Typically, fund houses put such exigency clauses in their offer documents and hence there are no uniform guidelines on gating practices currently. Gating practices defy the purpose of liquidity for which mutual funds are known for. Though such practices can limit investors from exiting the fund, it helps maintaining stability and restricts unnecessary redemption pressure. Earlier in August 2015, JP Morgan Mutual Fund had restricted redemptions in its two schemes – JP Morgan India Short Term Income Fund and JP Morgan India Treasury Fund having collective AUM of Rs. 2,964 crore.

SEBI has asked AMFI to issue guidelines for assessing credit risk of debt instruments. AMFI is likely to issue best practices guidelines on credit assessment practices soon. The decision was taken at a recently held meeting of SEBI Mutual Fund Advisory Committee.

Registrar and transfer (R&T) agents are reaching out to investors to comply with Foreign Account Tax Compliance Act (FATCA) guidelines. AMFI has recently issued uniform guidelines for fund houses to follow FATCA guidelines, which came into effect from November 1, 2015. AMCs are now updating the additional information of existing investors with the help of distributors and R&Ts. In the past three days, over 1 lakh investors have updated their records with CAMS. CAMS and Karvy have facilitated investors to update their details online. In addition, large distributors have been provided standardized format to electronically submit the declaration forms. The new declaration form requires information like type of address (residence, business, registered office, etc.), country of tax residence, tax identification number, Global Intermediary Identification Number (GIIN), and seeks investors consent for sharing the information with relevant tax authorities. FATCA is an anti-tax evasion law under which fund houses are required to report information on US investors to US IRS (Internal Revenue Service) through CBDT. India has agreed ‘in substance’ to FATCA by signing an Intergovernmental Agreement Model 1 (IGA-1) with US with effect from July 9, 2015. Simply put, the legislation is meant to prevent wealthy US individuals from parking money overseas to avoid paying taxes. Many AMCs had stopped accepting fresh investments from US investors due to stringent compliance requirement.

The Budget 2015 provision to levy Swachh Bharat Cess on all services comes into effect from November 15, 2015 according to a Central Board of Excise and Customs (CBEC) notification. This will increase the service tax burden of distributors by 50 basis points, which means the gross service tax payout goes up to 14.50%. According to industry estimates, the mutual fund industry paid Rs. 6,000 crore commission to distributors last fiscal. A 0.50% Swachh Bharat Cess translates into a payout of Rs. 30 crore. In 2012, the government had put the services of mutual fund agents under the negative list which exempted them from paying service tax. Till 2012, AMCs were deducting service tax and paying it to the government. In Budget 2015, this exemption was withdrawn.

Market regulator SEBI is likely to come out with guidelines on smart beta ETFs. Unlike regular ETFs which merely mimic a particular index, smart beta ETFs try to generate returns slightly higher than ETFs within the framework of passive management. This is a relatively new category in the Indian ETF landscape. Such products are one of the fastest growing categories in the international markets. A BlackRock report shows that as of December 2014, there are more than 700 smart beta ETFs listed around the globe, with $529 billion in assets. Indian fund houses are also trying to bring smart beta index funds/ETFs in India and SEBI is of the view that there is a need for bringing new rules for this emerging category to ensure such innovations do not pose a risk to investors. Since such funds are somewhat active in nature, the expense ratio could be higher than ETFs but lower than actively managed funds. In turn, the turnover ratio or the churning ratio of such funds would naturally be higher. One of the drawbacks of traditional ETFs is that they have exposure to underlying stocks which are weighted solely on market capitalization. Thus, the traditional ETF can be overweight on expensive stocks and underweight on cheap stocks. Smart beta ETFs try to fix this problem by using some attributes of active management.

Losses to unit holders and redemption pressure faced by JPMorgan Asset Management Company (AMC) in September 2015 have driven capital markets regulator SEBI to consider new investment limits for fund houses. According to a proposal under discussion, no fund manager would be allowed to invest more than 20% of a scheme in securities issued by companies belonging to a corporate group. While there are restrictions on the maximum amount that can be invested in a single company or sector, there is no cap on exposure to a single business group. The sector exposure limit is likely to be reduced to 25% from 30% while the single issuer limit may be brought down to 10% from 15%. The additional investment limit of 10% provided for securities issued by housing finance companies is also being reconsidered.

Equities and commodities market regulator SEBI has reiterated that research analysts — be it fundamental or technical — cannot deal/trade in securities that they recommend/follow in their research reports, 30 days before and five days after publishing a report. SEBI clarified in an informal guidance to Geojit BNP Paribas Financial Services that research entities shall not issue a research report that is not consistent with the views of individuals employed as analysts in a company.  SEBI added that in case contrarian views were held by research analysts employed in different teams of the research entity, the entity has to publish the report identifying the views of the different teams without altering them. The genesis of the issue lies in the fact that fundamental analysis is used to decide whether to buy a particular stock and technical analysis to decide when to buy and when to sell. Given the different nature of both the analyses, situations occur when a fundamental analyst gives a buy call on a stock while a technical analyst gives a sell call on the same stock. It also happens that while the retail research team of a brokerage house has a buy call on a scrip, the institutional research team may recommend otherwise.

A longstanding demand of distributors to get feeds of direct plan has finally been met. AMFI has sent a letter to fund houses communicating SEBI’s approval on providing feeds of direct plans to both distributors and RIAs. However, SEBI has asked fund houses to take prior approval of investors before sharing it with the intermediaries. Investors will have to give their consent in a standard format which is being worked out by AMFI. Also, SEBI has asked fund houses to issue a periodic declaration authorized by the trustees of AMCs that no consideration or brokerages are being paid to distributors or RIAs for such a service. Earlier, AMFI had requested SEBI to allow fund houses to provide direct plan feeds to the distributors and RIAs. It may be recalled that with the introduction of the direct plan, the distributor has been cut out. It was argued that tagging would enable the advisor to get access to client records for the investments recommended by him/her so that they could monitor their client portfolios. In other words, distributors wanted their ARNs to be tagged in direct applications so that they could get the feeds of schemes they recommend to their clients.

SEBI is likely to come out with a new regulation in which it will tighten disclosure norms for fund houses and intermediaries to make it more transparent. SEBI rules mandate fund houses to disclose commission payouts of top distributors on yearly basis on their respective websites. Currently, AMCs have to do due diligence of distributors who have multiple point presence (more than 20 locations), AUM over Rs.100 crore across industry in the retail category, commission received of over Rs. 1 crore per annum across industry and commission received of over Rs.50 lakh from a single mutual fund. In case a distributor has an excessive portfolio turnover, i.e. more than two times the industry average, AMCs have to do additional due diligence of such distributors.

Markets regulator, Securities and Exchange Board of India, will soon come out with measures to further strengthen investors’ confidence in the mutual fund sector. The mutual fund industry must come out with simple products that can be sold to people across India and they should be able to know the consequences i.e. the risks and rewards for investing in mutual funds. To increase investor participation in mutual fund sector SEBI had allowed cash transactions. This route has not been utilised to its full extent. Besides, online tractions mainly constitute about 16% and this route too has not been fully utilised.