FUND FULCRUM (contd.)

January 2018

Regulatory Rigmarole

NSE NMF II has introduced e-mandate facility on its mutual fund platform with immediate effect. The e-mandate facility would help mutual fund distributors to reduce the SIP registration cycle to just two to three days, as compared to two to three weeks earlier. Currently, MF distributors register paper based mandates for their investors, which is time consuming as it involves obtaining signature of an investor on the form and submission of physical form at the service centres for processing. The objective is to offer simple and hassle-free alternative to the MF distributors in the form of e-mandate wherein they  can register mandate of an investor online, which will be digitally signed based on Aadhaar based OTP validation. As per UIDAI website, there are approximately 119 crore Aadhaar numbers, which holds a huge potential for mutual fund industry which currently has 6.2 crore folios only. NSE has implemented e-mandates through HSBC (sponsor bank for the initiative) along with E-Mudhra (Certifying Authority licensed by Controller of Certifying Authorities, under Government of India) as an E-sign service provider. Digital platforms will be the game changers for Indian mutual fund industry.

Key features of this facility:

• e-mandate is available for individuals with single mode of holding

• Currently, maximum limit for e-mandate is Rs.1 lakh

• e-mandate is an Aadhaar based functionality, accordingly, registration of mobile number with UIDAI is mandatory for e-signing of mandate

• Updation of Aadhar number in bank account on which mandate is being registered is mandatory for mandate registration

• e-mandate can be registered for the banks enabled by NPCI for the same 

• At present 28 banks are participating for e-mandate service through NPCI

SEBI has reportedly asked a few fund houses to give details of breakup of their total expense ratio (TER). This is in the wake of alleged violation of AMFI’s best practices circular on commission structure of distributors.  In 2015, AMFI had issued its best practices circular to AMCs in which it had asked fund houses to discontinue ‘up fronting’ of trail across all schemes. In addition, it had put a cap of 1% on upfront commission and given freedom to fund houses to decide trail commission. However, it has to be within the distributable TER. Distributable TER is gross TER minus operating expense. A few AMCs pay as much as 2% as trail commission to their distributors. The market regulator wants fund houses to rationalise commission structure of distributors and management fee of AMCs. If TER comes down, naturally, fund houses cannot pay the commission they are paying today. IFAs cannot expect to increase their revenues through higher commissions.

In a move that will give distributors and investors a more complete picture of fund performance vis-a-vis its benchmark, SEBI has instructed fund officials to benchmark their schemes against Total Return Index (TRI), a benchmark that captures dividend income. Unlike traditional benchmarks, which do not take into account dividend income, TRI includes interest, capital gains, dividends and distributions realized over a given period of time. Simply put, TRI takes into account the dividends from companies, which is reinvested. Hence, TRI provides an apt measure to reflect the true alpha created by mutual funds. So far, two fund houses – Quantum Mutual Fund and DSP BlackRock Mutual Fund disclose performance of all active equity funds with the TRI. The NAV of a scheme includes income from dividends; however, the index, which the schemes follow to measure its performance do not capture gain from dividends. For instance, if the scheme gets 2% dividend over a year and it has outperformed its benchmark by 2.50%, then the extent of alpha generation is only 50 basis points and not 2%. In a circular, SEBI said, “At present, most of the mutual fund schemes (other than debt schemes) are benchmarked to the Price Return variant of an Index (PRI). PRI only captures capital gains of the index constituents. On the other hand, Total Return variant of an Index (TRI) takes into account all dividends/ interest payments that are generated from the basket of constituents that make up the index in addition to the capital gains. Hence, TRI is more appropriate as a benchmark to compare the performance of mutual fund schemes.” SEBI further said that fund houses could continue to use CAGR of TRI to compare the performance of the scheme with the benchmark. However, since the historical data of TRI may not be available, fund houses can use CAGR of PRI until the date from which TRI is available, according to SEBI. Value Research data shows that large cap schemes have outperformed Nifty 50 by 2.2% and 2.7% in three and five years respectively. Currently, the dividend yield of Nifty is at 1.25%, which shows that the large cap schemes have outperformed their benchmark by 1% and 1.5% over three and five years respectively. This circular will come into effect from February 1, 2018.

To avoid the potential conflict of interest, market regulator SEBI is considering imposing a 10% cross-shareholding cap in mutual funds. The new measure may have an impact on the shareholding pattern of UTI Asset Management Company (AMC). State Bank of India (SBI), Punjab National Bank (PNB), Bank of Baroda (BoB) and Life Insurance Corporation (LIC) are having their own mutual funds and at the same time they hold 18.24% stake each in UTI AMC. Under the proposal, any shareholder owning at least 10% stake in an AMC will not be allowed to have a 10% or more stake in another mutual fund house operating in the country. Further, a sponsor of a mutual fund, its associates, group companies and their asset management company will be restricted from holding a stake of 10% or more in a rival AMC. In addition, such entities will be barred from having a representation on the board of another mutual fund house. The new norms are aimed at avoiding any conflict of interest and help in strengthening the governance structure for mutual funds.

SEBI may come out with a new framework for Investment Advisor in order to segregate advisory and the role of a distributor. To prevent the conflict of interest that exists between 'advising' of investment products and 'selling' of investment products by the same entity/person, there should be clear segregation between these two activities. Existing registered investment advisers who are offering distribution services through a separate division would be given an option to choose between providing investment advice and distribution service before March 31, 2019. From April 1, 2019, any person, including their immediate relatives or holding or subsidiary or associate entity shall offer either investment advice or distribution services. SEBI Board has approved the consultation paper to seek public comments on following proposals:

i) There should be clear segregation between the two activities of the entity i.e. providing investment advice and distribution of the investment products/execution of investment transactions.

ii) Mutual Fund Distributors (MFDs), while distributing their mutual fund products can explain the features of products to client, and shall ensure the principle of ‘appropriateness’ of products to the client.”

iii)  Distributors cannot provide financial planning services such as risk profiling, financial goal setting, to their clients.

iv) Distributors will have to disclose the commission they earn.

In its budget proposals, AMFI has requested the Union Finance Minister Arun Jaitley to introduce Debt Linked Savings Scheme (DLSS) to channelize long term savings of retail investors into corporate bond market through mutual funds. “To deepen the Indian bond market and strengthen the efforts taken by RBI and SEBI for increasing penetration in the corporate bond markets, it is expedient to channelize long-term savings of retail segment into corporate bond market through mutual funds on the same lines as ELSS,” according to AMFI. Like ELSS, AMFI wants DLSS investors to avail benefits of tax deduction under Section 80C on investments of up to Rs.1.50 lakh. However, AMFI has recommended that DLSS should have lock-in of 5 years. If implemented, this will also bring debt oriented mutual funds  on  par  with  tax  saving bank  fixed deposits,  where  deduction  is  available under Section 80C. Further, it is proposed that DLSS should invest at least 80% of its corpus in the bonds issued by the listed companies as permitted under SEBI Mutual Fund Regulations. Further, the scheme is to be allowed to put another 20% of its corpus in short term money market instruments. In the proposal, AMFI said that the introduction of DLSS would help small investors participate in bond markets at low costs and at a lower risk as compared to equity markets. Earlier in 1992, the government had notified the ELSS to encourage investments in equity funds. Over the years, ELSS has been an attractive investment option for retail investors. Over the years, several committees such as the R.H. Patil committee (2005), Percy Mistry committee (2007) and Raghuram Rajan committee (2009) have studied various aspects related to bond market and have made recommendations to the government to strengthen corporate bond market through effective retail participation.

In India, mutual fund investment is equal to 4% of GDP as against 60% of GDP in the USA. It is not very surprising that the mutual fund penetration in our country is low but it is definitely increasing. Assets have been historically concentrated towards physical assets like real estate and gold. However, this is set to change with demonetisation and awareness campaigns.