FUND FULCRUM (contd.)

December 2018

The asset under management (AUM) of the mutual fund industry rose by 13% to Rs 24 lakh crore in 2018 by the end of November itself, up from Rs 21.26 lakh crore at the end of December 2017, according to data available with the Association of Mutual Funds in India (AMFI). However, the final AUM figure at the end of December 2018 might be slightly lower than that of November 2018 as there could be a dip in liquid funds due to the quarter-end phenomenon. The industry's AUM had crossed the milestone of Rs 10 lakh crore for the first time in May 2014 and in a span of about four-and-a-half years, the asset base is up more than two-fold to Rs 24 lakh crore in November 2018. It had crossed the Rs 25 lakh crore mark also at the end of August 2018. The year 2018 would mark the sixth consecutive yearly rise in the industry AUM after a drop for two preceding years. Mutual funds have added a whopping Rs 3 lakh crore to their asset base in 2018 and the uptrend may continue in 2019, helped by consistent rise in the SIP flows and a strong participation of retail investors despite volatile markets. Moreover, a sharp rise in SIPs shows more people moving away from the concept of large lump-sum investments. Fund houses have garnered over Rs 80,600 crore through SIPs --a preferred route for retail investors to invest in mutual funds as it helps them reduce market timing risk. The industry added close to 10 lakh SIP accounts each month on an average in 2018 with SIP collection on a monthly basis increasing to over Rs 6,700 crore this year from more than Rs 4,950 crore in 2017. Another highlight of 2018 was a surge in the number of investor accounts and equity folios contributed tremendously to this growth. Overall, investor folios climbed by 1.32 crore to 8 crore while retail investor accounts -- defined by folios in equity, ELSS and balanced categories -- alone grew by 1.25 crore to 6.7 crore. Besides, equity and equity-linked saving schemes (ELSS) attracted an impressive inflow of Rs 1.15 lakh crore. The pace of growth, however, declined for the asset size in 2018 as compared to 2017. The industry had seen a surge of 32% in the AUM or an addition of over Rs 5.4 lakh crore in 2017. The IL&FS default and the consequent blow to the NBFC sector because of the credit crunch exposed mutual funds to lakhs of crore worth of ill-liquid debt funds. This coupled with volatile markets could be some of the reasons for a slower growth in assets base this year. The factors that will drive the growth in 2019 include the untapped potential, rising investor awareness about mutual funds as an investment alternative and a spirited promotion campaign by AMFI.

Regulatory Rigmarole

Markets regulator SEBI has issued new norms to cap total expenses for investment in mutual funds at 2.25%. The regulator has capped the maximum TER for closed-ended equity schemes at 1.25%, and other than equity schemes at 1%. The maximum TER for open-ended equity schemes will be 2.25% and 2% for other open-ended schemes. With regard to open-ended equity schemes, SEBI said that the highest expense ratio allowed to be charged for the first Rs 500 crore of assets will be 2.25%. As AUM increases, the expense ratio will have to come down. For the next Rs 250 crore, it will be 2%; for further Rs 1,250 crore, it will be 1.75%; for the next Rs 3,000 crore, the fee will be 1.6%; and again on the next Rs 5,000 crore of the daily net assets, the charge will be 1.5%. In the case of equity mutual funds with the daily net assets of Rs 40,000 crore, SEBI said that total expense ratio will be a decline of 0.05% for every increase of Rs 5,000 crore of daily net assets. Rationalising the total expense ratio (TER), the fee that mutual funds collect from investors every year to manage their money, SEBI said the new fee structure would come into force from April 1, 2019.

Distributors earning over Rs.20 lakh a year can update their GST identification online on AMFI website. These distributors can avail of the benefits of input credit. GST norms mandate distributors earning over Rs.20 lakh a year to take GST registration. The limit is Rs.10 lakh for distributors from special states comprising Arunachal Pradesh, Assam, Jammu and Kashmir, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura, Himachal Pradesh and Uttarakhand. Currently, the government has put distributors earning less than Rs.20 lakh a year and those who do not have GST registration from GST under reverse charge mechanism (RCM) until March 31, 2019. This means, such distributors will get gross commission.

AMFI has reintroduced online ARN renewal process for distributors. Earlier in October 2018, following the Supreme Court’s verdict on Aadhaar, AMFI had discontinued online registration and renewal of ARN for mutual fund distributors. However, the trade body has restarted online renewal process for distributors through Aadhaar. The process of ARN renewal is completely paperless and based on Aadhaar. Aadhaar is required to be linked with the mobile number to avail this online facility. In addition, the mark sheet of NISM Mutual Fund Distribution examination is no longer required to renew ARN. The renewal fees can be paid through net banking facility. Currently, distributors have to send their certificates to CAMS along with a DD of Rs.1,770 in favour of the Association of Mutual Funds in India as renewal fee. For new ARN and EUIN registration, distributors will have to go through physical process i.e. visit CAMS office with relevant documents such as PAN, Aadhaar, two passport size colour photos, DD of Rs.3540 in favour of Association of Mutual Funds in India, ARN registration form, KYD form and NISM pass certificate. They will have to undergo biometric for KYD.

SEBI will soon prescribe guidelines on pricing corporate bonds. All mutual funds will have to follow the valuation methodology. This will ensure uniformity in terms of valuation of corporate bonds across mutual funds. Moreover, SEBI would develop a supervisory and regulatory framework for pricing agencies, which would provide corporate bond pricing services related to mutual funds. Since debt securities are illiquid in nature and not traded like equities, mark-to-market valuation is challenging for fund houses since they have to quote NAV on a daily basis. Hence, most fund houses rely on rating agencies to derive NAV. Often rating agencies look at accrual to value debt securities. Credit rating agencies reflect the rating agencies’ opinion about the credit risk of debt securities based on historical data and some assumptions about the future, which tends to underplay the possibility of default. Following IL&FS default, SEBI wants to reduce risk in debt funds. One of the proposals being reportedly considered is allowing mark-to-market valuation of debt securities having maturities of less than 60 days. Furthermore, the pricing agencies may seek advice from mutual funds while evaluating the fair price of illiquid lower rated instruments. SEBI’s proposal to develop a framework for pricing agencies might help bring better transparency and uniformity in this segment and facilitate better risk management across the industry.

Sebi is planning to allow mutual funds to undertake 'side pocketing' of debt and money market instruments in case of a credit event while ensuring fair treatment to all unitholders. 'Side pocketing' is a mechanism to separate distressed, illiquid and hard-to-value assets from other more liquid assets in a portfolio. It prevents the distressed assets from damaging the returns generated from more liquid and better-performing assets. The proposal comes in the wake of the liquidity squeeze triggered by the Infrastructure Leasing & Financial Services (IL&FS) default. IL&FS and its subsidiaries have defaulted on several debt repayments recently due to liquidity crisis. Under the proposal, side pocketing may be permitted for debt instruments in mutual fund schemes based on credit events at issuer level. It may be optional for mutual funds to exercise such mechanism. Further, activation of side pocketing would be subject to trustee approval and there should be monitoring by trustees to ensure timely recovery of side pocketed assets as per the proposal. Also, there should be adequate disclosure to existing and prospective investors to enable informed decisions.

The long-awaited Self-Regulatory Organisation (SRO) for distributors is close to becoming a reality. SEBI has asked AMFI to start preparations for SRO. The SRO will assist SEBI and AMFI in regulating fund distributors and ensuring a cordial relationship with mutual fund houses. The SRO for mutual fund distributors will be responsible for micro-regulations of its members, spread awareness about mutual fund products among people, educate and train distributors and conduct screening test for them. The decision to set-up a SRO followed concerns about mutual fund distributors not being regulated and complaints against them for mis-selling products.

A recent CII and McKinsey report estimates that Indian mutual funds will grow at a CAGR of 18% to reach an AUM of Rs.50 lakh crore by 2023. The report said that the Indian market is on a strong growth trajectory. However, compared to other global markets, the Indian mutual fund industry is still at a nascent stage. The report predicts the key trends that will contribute to the growth of the Indian mutual fund industry. Mutual Funds are becoming a key investment vehicle as assets parked in cash and deposits are moving to investment products. Mutual funds as a share of bank deposits have grown from 12% to 20% in the last three years. Regulatory push (in terms of TER incentive) to spread mutual funds beyond top cities has led to B30 cities gaining prominence in the industry AUM mix. Retail investors are slowly increasing their allocation via the direct route. The effect is expected to be more pronounced with new-age online channels providing a low cost and easy investment option. Regulatory push for transparency and simplicity, organising financial inclusion programs country-wide, focus to reduce the cost of investment through rationalisation of TERs and change in the pay-out framework are some of the investor-centric measures initiated by the regulator and the industry.