FUND FULCRUM

September 2018

The Indian mutual fund industry showed remarkable resilience in the face of declining currency, increasing oil prices and market volatility by reaching close to the quarter lakh crore mark for the first time, according to AMFI data. While the month end AUM stood at Rs. 25.20 lakh crore, the average for the month was slightly lower at Rs. 24.70 lakh crore. In the last decade, the mutual fund industry has grown by nearly 5 times from Rs. 5.45 lakh crore on August 31, 2008 to Rs. 25.20 lakh crore as on August 31, 2018.  The growth has been more aggressive in the last five years with the industry AUM increasing three fold from Rs. 7.66 lakh crore (on August 31, 2013). In fact, after touching the Rs. 10 lakh crore mark in May 2014, the industry has been beating one milestone after the other. Customer centric regulations by SEBI and AMFI’s initiatives have played a pivotal role in bringing customers from smaller cities into the mutual fund’s fold.

The year 2018 has been a volatile one so far for both equity and debt markets. However, investors seem to be resilient to market vagaries. This is reflected in the steady increase in the number of folios. In the one year period ending August 2018, the industry has added over 1.57 crore folios. In fact, of the total 1.57 crore folios, close to 1.5 crore folios were in equity funds. Equity funds include pure equity funds, ELSS, balanced funds and ETFs. Income funds recorded only a marginal increase in folios (3.55%). Meanwhile, gold ETF (32,823) and gilt funds (28,147) saw a decline in folios. In percentage terms, liquid funds saw the highest increase in folios (48.19%) followed by equity funds (30%). On the other hand, gilt funds recorded a 30% decline in their total folio count. The month of August 2018 saw 10.8 lakh new folios being added. The monthly trend was in line with the annual data.

SIPs have been the preferred route for retail investors to invest in mutual funds as it helps them reduce market timing risk. According to the latest data, SIP contribution in August 2018 was Rs 7,658 crore, a little higher than Rs 7,554 crore seen in the preceding month. In comparison, the industry garnered Rs 5,206 crore in August 2017 and Rs 3,496 crore in August 2016. SIP flows seem to have contributed predominantly to inflow in mutual fund schemes as investors remained wary of expensive valuations amid rising concerns over high oil prices and rupee depreciation. On a year on year basis, SIP flows have grown by 47% compared to last year. 90% of the SIP flows have come in equities. This translates to equity schemes seeing Rs. 6,892 crore of inflows in August 2018 through the SIP route. AMFI data shows that equity funds reported sales of Rs.25,393 crore during the month. This means that, 27% of the equity flows come through the SIP route. So far, the industry has received SIP flows worth Rs. 36,760 crore since April 2018.  At the corresponding period last year, the industry had collected Rs. 23,750 crore. The data also reported that the total mutual fund accounts stood at 2.38 crore at the end of August 2018 rising from 2.33 crore in the previous month. Overall, the industry added about 10.07 lakh SIP accounts on an average each month during the financial year. The average SIP size was Rs. 3,200 per account.

Piquant Parade

Principal Financial Group announced the completion of a full share buyback of Punjab National Bank shares giving the financial group full ownership of their joint venture, Principal PNB Asset Management Company Private Limited. Punjab National Bank had 21.38% stake in Principal PNB AMC. However, Punjab National Bank will continue to distribute the schemes of Principal Mutual Fund through its branch network. Principal has been in India for nearly 20 years, offering investment products and services to retail and institutional clients. As at the end of June 2018, the average assets under management of Principal Mutual Fund stood at Rs 7,418 crore.

Regulatory Rigmarole

Pension fund managers of National Pension Scheme (NPS) cannot invest more than 5% in equity mutual funds from now. Pension Fund Regulatory and Development Authority (PFRDA) has written to pension fund managers asking them to restrict the exposure to 5% of the total portfolio of the fund. This will mean that going forward, each of the securities will have to be reviewed and a blanket investment into an equity mutual fund will not be permissible. Pension fund managers invest into a range of instruments in the equity and debt segment to have a diversified portfolio and offer risk-weighted returns to customers. PFRDA recently allowed NPS customers to invest up to 75% into equity instruments. Pension fund managers are responsible for allocating the money invested by customers into different instruments. Here, instead of looking at securities and choosing between them based on the past performance and future prospects, pension fund managers were investing directing into equity Mutual Funds which relieved the Pension Fund Managers of the responsibility of actively managing the funds and thereby save costs.

The Mutual Fund Advisory Committee (MFAC) has recommended to SEBI that the market regulator should consider introducing performance linked fee structure in the Indian mutual fund industry to rationalize TER. While underperforming schemes will no longer enjoy similar TER as of performing schemes, such schemes cannot attract fresh inflows after three years. The committee has reportedly suggested SEBI that if a scheme underperforms its benchmark by 2% in the first year, fund house will have to reduce TER by 0.25%. Further, such a scheme will have to reduce its TER by another 0.25% in the second year if it continues to underperform its benchmark by 2%. Finally, in the third year of underperformance to the extent of at least 2%, the scheme will have to reduce its TER by 0.50%. Also, such a fund house will have to close subscription for fresh sales on its scheme after three years of underperformance. On the other hand, if a scheme outperforms its benchmark by 5%, fund houses can increase its TER by 0.25%. Performance linked fee is prevalent in a few developed markets. In the most recent examples, two leading global investment houses - Fidelity International and Allianz Global Investors have linked their management fees with the performance of their active schemes. While Fidelity International follows this model for charging fees on its funds sold internationally, Allianz Global charges investors a management fee only if they beat their benchmarks across all active schemes. In fact, a few fund houses such as Orbis Investment Management operate many of their active funds on a ‘no performance no fee’ model; the company refunds cash to investors if their funds underperform their respective benchmarks. Many of these investment houses have been under pressure to justify charges under active funds. In 2005, Sahara Mutual Fund had introduced such a model in India. However, the model did not fare well among investors and distributors. The fund house had segregated the fee structure in two buckets– recurring expenses and management fees. While they did not touch recurring expenses, the management fees varied with the performance. For instance, if the fund delivered positive returns but did not manage to beat its benchmark, the fund house charged half the management fees. Similarly, the fund house charged full management fee if the fund outperformed its benchmark. There were no management fees on negative returns and underperformance.

In a communication with distributors, AMFI has cautioned distributors against using the word ‘mutual fund’ in suffix and prefix of email labels. Simply put, if you are sending an email communication from your email id viren@makeyouwealthy.com, you cannot use ‘Viren Mutual Fund’ as the sender’s name on your email communication. SEBI and AMFI have noticed instances where distributors have communicated with clients through their email IDs by using the word ‘mutual fund’ on sender’s name. AMFI said, “Recently certain instances were brought to the notice of AMFI and SEBI, wherein the mutual fund distributors had adopted email labels suffixed with the words "Mutual Fund" [for example, "ABC Mutual Fund" or  XYZ Mutual Fund" {where ABC & XYZ are  the names of the ARN holders} while sending promotional "no-reply" emailers regarding mutual fund investment.” AMFI has asked distributors not to use such names in their email labels to mislead investors. “While the concerned distributors were advised by AMFI to stop using such names immediately as such email labels could be mistaken to have been sent by a genuine mutual fund by uninformed persons, AMFI's ARN Committee and the Board of Directors of AMFI have expressed concern in this regard, and have advised that mutual fund distributors should refrain from using the term "Mutual Fund" in their email label or in their proprietary names in any manner,” added AMFI. A few months back in April 2018, AMFI had cautioned distributors against tweaking the ‘Mutual Fund Sahi Hai’ (MFSH) campaign line to promote their own business. AMFI has found instances where some distributors and IFA associations have violated SEBI guidelines by using the ‘Mutual Fund Sahi Hai’ logo inappropriately.

SEBI has asked fund houses not to pay upfront commission to mutual fund distributors. In fact, the market regulator has asked fund houses to follow all-trail model to compensate their distributors. The market regulator has clarified that fund houses will have to pay such commissions from the scheme and not from the AMC book. In addition, SEBI has asked fund houses not to do upfronting of any trail commission. However, fund houses can do upfronting of trail commission on SIPs subject to fulfilment of pre-defined conditions. In a press release, SEBI said, “All commission and expenses, etc. shall necessarily be paid from the scheme only and not from the AMC/Associate/Sponsor/Trustee, or any other route. Further, the mutual fund industry must adopt the full trail model of commission in all schemes without payment of any upfront commission or upfronting of any trail commission. A carve out has been provided for upfronting of trail commission in case of SIPs subject to fulfilment of certain conditions.” On TER structure, SEBI has introduced fresh AUM slabs and given a roadmap to fund houses on how they can make changes to their TER based on asset size of the scheme. While the market regulator has capped TER at 2.25% in equity funds and 2% in other than equity funds, SEBI has followed economies of scale to reduce TER systematically. Similarly, fund houses cannot charge more than 1.25% in close end equity funds and 1% in close end debt funds. SEBI has also asked fund houses to charge a maximum TER of 1% on passive funds such as index funds and ETFs. On fund of funds (FOFs), SEBI has said that FOFs investing in liquid, index and ETFs cannot charge over 1%. On the other hand, FOFs investing primarily in actively managed funds can charge up to 2.25% in equity funds and 2% in other than equity funds. SEBI said that the slab wise limits of TER were introduced in 1996 and observed that over time, there have been varying practices in the industry with respect to charging of expenses and payment of commissions. SEBI said, “The Board took note of the benefits of the proposal with respect to sharing of economies of scale, lowering the cost for mutual fund investors, bringing in transparency in appropriation of expenses, and reducing mis-selling and churning.” SEBI has also clarified that the additional expenses of 30 bps for penetration in B30 cities is applicable only if assets come from retail investors. “The additional incentive shall be permitted for inflows from individual investors only and not on inflows from corporates and institutions. Further, the B-30 incentive shall be paid as trail only. The market regulator has also asked fund houses to disclose performance of their schemes against its total return index benchmark on AMFI website.

Over the last few years SEBI has come up with many rules and regulations for making the lives of investors simpler. AMFI is doing its bit too – with the high decibel and highly engaging ‘Mutual Funds Sahi Hai’ and now the ‘Jan Nivesh’ initiative to make mutual funds known to the retail investors that much better.