Monday, January 28, 2019


FUND FULCRUM
January 2019

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. The asset under management (AUM) of the industry rose by 13% to Rs 24 lakh crore in 2018 by November-end itself, up from Rs 21.26 lakh crore at the end of December 2017, according to data available with AMFI. The investor count is also estimated to have grown by over 1.3 crore during 2018. 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 AUM in December 2018 fell 4.9% to Rs 22.86 lakh crore over November 2018. The IL&FS default and the consequent blow to the NBFC sector because of the credit crunch exposed mutual funds to several crores worth of ill-liquid debt funds. This coupled with volatile markets could be some of the reasons for a slower growth in assets base in 2018. Going into 2019, the fund houses expect the industry to witness robust growth as the sector is yet to tap its full potential. Besides, several measures taken by the regulator SEBI will help in increasing the penetration of mutual funds. 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.

Equity fund folio addition has boosted the domestic mutual fund industry, helping it register over 5.7 lakh more investor accounts in December 2018, according to the data of the Securities and Exchange Board of India (SEBI). Total investor accounts stand at 8.03 crore in December 2018. In comparison, the 43-player industry had added 7.05 lakh folios in November 2018 and 11.5 lakh folios in October 2018. Equity folios halved from 10.6 lakh folios in October 2018 to 4.91 lakh folios in December 2018. Equity funds include pure equity, ELSS and balanced funds. Fund managers attributed the addition in equity fund folios to the matured behaviour of retail investors who were seeing the market fall as an opportunity to invest their surplus money. Folios in equity ETF rose 3.75%, gilt funds (3.41%) and liquid funds (2.58%) grew at the fastest pace during the review period. Interestingly, income funds reported a marginal increase in their folio counts, against the decline observed in the last few months. Income funds reported net outflow during the month, with macroeconomic variables turning favourable. With no further expectation of a rate hike in the near term, the increase in investor folios suggests they may be slowly returning to this category.

HDFC Mutual Fund reclaimed its position as the country’s top asset manager by assets after a gap of nearly three years. In the last quarter ending September 2018, HDFC Mutual Fund had stood at the second spot behind ICICI Mutual Fund with quarterly average assets of Rs. 3.06 lakh crore. While ICICI AMC saw net outflows to the tune of Rs. 2,522 crore during the quarter ending December 2018, HDFC Mutual Fund recorded inflows of Rs. 28,604 crore propelling it to the top position. Most fund houses saw a decline in their AUM in the quarter ending December 2018. Overall, the industry AUM fell by 3% last quarter. The industry AUM had touched an all-time high of Rs. 25.20 lakh crore in August 2018. However, post September 2018, macroeconomic concerns and NBFC credit event led to outflows from debt funds. Subsequently, mutual fund AUM for the quarter ending in December 2018 fell from the September 2018 quarter level. Among the top 10 mutual funds, only HDFC Mutual Fund, SBI and Kotak Mahindra Mutual Fund recorded an increase in their assets while the remaining fund houses saw a decline in their AUM. On gross basis, HDFC Mutual Fund saw the highest increase in its AUM (Rs. 28,604 crore) while DSP Mutual Fund saw the highest fall (Rs. 16,212 crore). In percentage terms, Shriram Mutual Fund (87%), PPFAS Mutual Fund (14%) and HDFC Mutual Fund (9%) were the fastest growing fund houses during the quarter while DHFL Pramerica Mutual Fund (53%), Indiabulls Mutual Fund (53%) and LIC Mutual Fund (35%) saw the sharpest decline in their assets.

The top five fund houses account for 71% of the industry’s profit, according to HD ‘Asset Management Companies’ report. PAT (profit after tax) denotes the fund house profit. Overall, the mutual fund industry has witnessed a 26% (CAGR) growth in its assets from Rs. 8.25 lakh crore in FY 14 to Rs.24.03 lakh crore in November 2018.  In line with the growth in AUM, the PAT of the industry grew 28% during FY 14 to FY 18. A key reason for the growth in profitability is the rising share of equity assets in the industry. The share of equity vis-à-vis the total industry AUM has grown continuously since 2014. Over the last four years, the equity AUM grew at 36% CAGR to reach Rs.9.20 lakh crore. As of November 2018, 40% of the industry assets were in equities compared to 25% in FY2014. According to the report, fund houses having higher equity assets tend to deliver higher returns on assets represented by PAT as a percentage of AUM.

Over the last two years, SIP has been a driver of steady inflows in the industry. In fact, the latest AMFI data shows the industry’s SIP collection for the FY year 2018-19 (Rs. 68,479 crore) has already surpassed the total collection in FY17-18 (Rs. 67,190 crore). Assuming the monthly SIP inflows continue at the current level (Rs. 8,022 crore) for the next three months, the industry will receive Rs. 92,545 crore as SIP inflows in FY 18-19. This will be a 38% increase over the previous year’s collection. SIP flows grew by 53% in FY17-18. While we may see some uptick in SIP inflows near the end of the year, the momentum in SIP seems to have slowed. As per recent AMFI data, on a net basis SIP flows grew by Rs. 37 crore to reach an all-time high of Rs. 8,022 crore last month. The industry also added 2 lakh SIP accounts on a net basis in December taking the total to 2.54 crore SIP folios. On an average, the industry has added 9.46 lakh SIP accounts each month in FY 18-19.

Piquant Parade

IDFC has shelved plans to sell the asset management company. After spending months searching for a buyer, IDFC Financial Holding Company - a part of IDFC - has decided to retain its fund management business. The board of the group company felt that it makes sense to hold the fund house and grow it over time rather than sell it. IDFC has now decided to focus on making its underlying businesses more retail-focused. The fund house failed to elicit the kind of valuation it sought. While the fund house expected around Rs 5,000 crore, it got bids in the range of Rs 3,500 – 4,000 crore. Avendus Capital, Reliance Nippon Life Asset Management, IndusInd Bank, BlackRock Inc. were among the firms that expressed interest in buying. Of the above bidders, its talks with Avendus were in the final stages. However, the deal did not go through.

LIC Mutual Fund is likely to acquire IDBI Mutual Fund. This has come after LIC has bought 238 crore equity shares of IDBI bank amounting close to Rs.14,500 crore. Earlier in October 2018, Life Insurance Corporation of India (LIC) made an open offer to acquire 26% stake in IDBI Bank. The acquisition might take some time due to regulatory approvals. As per December 2018 quarterly AUM, LIC MF manages Rs.13,378 crore and IDBI MF Rs.8599 crore. If the deal goes through, the AUM of the combined entity would be close to Rs.22,000 crore. Currently, by AUM size, LIC MF ranks nineteenth and IDBI twenty-fifth. The combined entity would overtake Mirae Asset and Motilal Oswal to reach sixteenth position. This acquisition would allow LIC MF to leverage IDBI’s branch network and target clients in B30 locations.

HDFC Securities in a recent report observed that amongst the bank backed fund houses Axis MF (47.6%) has highest reliance on its associate bank followed by SBI MF (35.2%). Meanwhile, Kotak MF (8.8%) has the least dependence on its associate bank amongst the top nine fund houses. In absolute terms, SBI brought inflows of close to Rs. 90,000 crore for SBI MF. In the second place comes ICICI MF where ICICI Bank contributed around Rs. 56,000 crore in AUM. What this means is that bank sponsors continue to drive substantial inflows for their associate fund houses. This is not surprising because with their large branch network banks can reach a wider retail consumer base. Consequently, mutual funds with associate banks tend to fetch higher premium in mutual fund space. Moreover, in the last few years, third party cross-selling that is selling other financial products like insurance and mutual funds has become a lucrative income stream for banks. In terms of inflows from non-associate AUM, UTI MF (90.6%) ranks at the top spot followed by Franklin MF (81.5%) as these fund houses do not have any bank promoter.

Regulatory Rigmarole
 After giving the green signal to side-pocketing, SEBI has given the option to fund houses to segregate bad assets. But there are strict conditions to prevent misuse. Debt mutual funds will now be able to segregate their portfolios and carve out bad securities. The capital market regulator, Securities and Exchange Board of India (SEBI) said, in a circular, that in case where the credit rating of an instrument held by a debt fund gets downgraded to "below investment grade" (below BBB-rating) then fund houses can choose to segregate such bad securities and allow investors to continue to buy or sell the good portion of the scheme. The segregated portfolio will not allow any fresh investments. In simple words, your holding in the scheme would be split into two; the good part and the bad part, with an equal number of units in both. You can choose to sell the good units and exit, but the bad units will be frozen until your fund recovers the dues from the bad assets. Both the good and bad (segregated) part of your scheme will have net asset values (NAV). SEBI has given the option to fund houses to decide whether or not they want to go ahead and segregate assets. But fund houses will not be able to do this immediately. The market regulator has mandated that those fund houses who think they may use this facility need to first mention it in their Scheme Information Documents (SID).

 

Keeping in mind the growing instances of cybercrimes globally, SEBI has asked fund houses to put in place robust cyber security and cyber resilience framework to deal with such cyber threats and data breach. In a circular, SEBI said, “With rapid technological advancement in securities market, there is greater need for maintaining robust cyber security and to have a cyber-resilience framework to protect integrity of data and guard against breaches of privacy.” Here are some key highlights of the circular
·         AMCs will have to appoint Chief Information and Security Officer (CISO) who will assess, identify and reduce cyber security risks, respond to such incidents and establish appropriate controls
·         AMCs board will have to constitute technology committee comprising experts in technology. This committee will review existing framework of the AMCs and instances of cyber security on a quarterly basis
·         MFs will have to identify their critical assets, which are prone to such risks
·         MFs will have to encourage third party providers, RTAs, custodians, brokers and distributors to have similar standards of information security
·         MF officials of any rank do not have right to access confidential data. Any access to AMCs should be for a defined purpose or defined period
·         MFs will have to implement strong password for users’ access to systems, apps and networks. AMCs will have to provide two-factor authentication at log in.
·         MFs will have to deploy additional controls and security measures to supervise staff
·         Employees and outsourced staff who have access to such systems will be subject to stringent supervision and access restriction
·         Alerts should be generated in an event of detection of unauthorized system activity
·         MFs have to impart trainings to employees and outsourced staff to increase awareness
The circular will come into effect from April 1, 2019.

SEBI has asked fund houses to reduce portfolio concentration risks in index funds and ETFs. Here are some key highlights of the circular
·         ETFs/ index funds can only mimic an index having a minimum of 10 stocks as its constituents
·         No single stock shall have more than 35% in the index. For sectoral or thematic indices, such a weightage cannot be more than 25%.
·         The weightage of top three constituents of the index should not exceed 65% of the index
·         The individual constituent should be frequently traded i.e. with frequency of at least 80%
The circular will be come into effect from April 10, 2019.

SEBI has opened up covered calls to the mutual fund industry. Covered calls are a complex strategy in which a fund manager can write a call option contract if he has neutral view on a particular stock. Unlike derivative strategies where volatility has a key role to play, covered calls work well in flat market conditions. Through this, the scheme can generate money to the extent of premium paid by traders. In the circular issued, SEBI said that equity fund managers could write call options only under a covered call strategy for stocks traded on Nifty 50 and BSE Sensex. However, the total notional value of such call options should not exceed 15% of the total market value of equity shares held in that scheme. The total number of shares underlying the call option should not exceed 30% of the unencumbered shares in a scheme. SEBI further clarified that schemes cannot write call option of a share if it is not underlying. Also, a call option can be written only on shares which are not hedged using other derivative contracts. The fund house will have to do mark to market valuation of NAV by factoring in respective gains or loss into the daily NAV of the scheme. Earlier in August 2018, SEBI had constituted a sub-committee of the mutual fund advisory committee (MFAC) to look at the pros and cons of introducing covered calls in mutual funds. Such a strategy is well suited for long term players like mutual funds. This would help investors generate marginal returns even during flat market conditions.

In a letter issued to JM Financial, SEBI has clarified that alternative investment funds can invest its unutilized funds in the units of liquid funds. AIFs can also invest their unutilized portion in bank deposits and liquid assets of higher quality such as treasury bills, commercial papers and certificate of deposits. However, AIFs will have to keep their unit holders informed about such exposures, said SEBI. In the letter, SEBI said, “The provisions under regulations is provided in the interest of investors with respect to un-invested portion of the investable funds till deployment of these funds as per the investment objective. Considering this, SEBI registered AIFs may invest investment income or proceeds arising from sale/transfer of the investment or returns from the investment (dividend or interest on securities) in liquid funds, bank deposits or other liquid assets of higher quality. However, to ensure the transparency and disclosure requirements as specified in AIF regulations, the AIFs shall disclose information about the proposed transaction periodically to the investors.” Earlier, JM Financial sought a clarification if JM Financial India Fund II, a category II AIF can invest unutilized funds arising out of receipt of proceeds from sale/transfer of investment or returns earned from investments such as dividend or interest in liquid funds.

SEBI has revised reporting norms for mutual funds. The new Monthly Cumulative Report (MCR) will capture details such as number of folios in each scheme, gross inflows, net inflows/outflows, net AUM, Average AUM and so on. AMCs will have to do such reporting at scheme level. The revised MCR is in line with the categorisation and rationalisation of mutual fund schemes that aims to eliminate duplication in offerings across schemes within the fund house. The new report directs fund house to put one scheme in each category. The new reporting norms will come into effect from April 1, 2019. AMCs will have to ensure that they share the report within three working days of the month.

In a major relief to mutual fund distributors, the government has deferred the implementation of reverse charge mechanism (RCM) till September 30, 2019. The move will benefit mutual fund distributors, who do not have a GST registration number and who have surrendered their GST registration number. These distributors should have earnings of less than Rs.20 lakh a year. For distributors with GST registration, AMCs continue to follow forward charge mechanism, i.e., AMCs will pay the gross commission to them. These distributors can avail of the benefits of input credit. Earlier this month, the government introduced composition schemes for services sector. Under the scheme, service providers earning up to Rs.50 lakh could pay GST rate of 6% instead of 18% with effect from April 1, 2019. However, these service providers cannot avail input credits if they opt for the composition scheme. Also, they will have to pay taxes quarterly but file returns annually. Moreover, the composition scheme in the current form does not allow service providers to avail benefits if they have interstate services.

The year 2018 was an action-packed one for the Rs 23 lakh crore Indian mutual funds industry as well as for investors in it. While the S&P BSE Sensex gained 6% year-to-date, equity funds disappointed. Large-cap funds fell 4% on an average in 2018, mid-cap funds were down 14% while small-cap funds were off a steep 21%, as per Value Research. Funds got friendlier as costs were pushed down and steps were taken to curb misselling. Fund categories - and all schemes within - got standardised. This made it easier for investors to compare one fund with another. The major piece of bad news, however, was the introduction of long-term capital gains tax (LTCG) on equity funds in Budget 2018. How far the provisions of Budget 2019 impacts the mutual fund industry remains to be seen.



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