FUND FULCRUM
August 2010

The assets under management of the Indian mutual fund industry plunged for the second straight month in July 2010, falling 1.5% as against a steep slide of 16% in June 2010. The combined average AUM of the 39 fund houses stood at Rs 6,65,567 crore in July 2010, a fall of Rs 10,296.15 crore. Reliance Mutual Fund, the largest fund house in the country, saw an addition of Rs 859 crore to its average assets at Rs 1.02 lakh crore. However, the assets of the other top fund houses - HDFC Mutual Fund (Rs 2,019.89 crore), ICICI Mutual Fund (Rs 5,080.31 crore), and UTI Mutual Fund - declined during the month on the back of huge withdrawals by corporates and banks. Funds that saw an increase in average AUM include SBI Mutual Fund (Rs 4,779 crore), Baroda Pioneer Mutual Fund (Rs 879 crore), Fidelity Mutual Fund (Rs 186 crore), Fortis Mutual Fund (Rs 190 crore), JP Morgan Mutual Fund (Rs 2,284 crore), and Peerless Mutual Fund (Rs 156 crore). However, certain fund houses including Birla Sunlife Mutual Fund, L&T Mutual Fund, Tata Mutual Fund, and Taurus Mutual Fund witnessed a substantial erosion in their AUM.

The mutual fund industry saw a net outflow of Rs 8,000 crore (Rs 1531 crore in June 2010 and Rs 3539 crore in July 2010) in equity funds and lost over 600,000 equity folios over the past one year since the ban on entry load came into effect on August 1, 2009. AUM of equity funds witnessed an increase of 15% between between July 31, 2009 and June 30, 2010 because of capital appreciation and not because of fresh inflows. In normal situation, inflows into equity funds should have been very huge given the kind of growth we saw in equity markets. During the August 2009-June 2010 period, equity funds saw a net outflow of Rs 8,160 crore. During the corresponding period in 2008-09, one of the worst times for the Indian equity markets, equity funds registered a net inflow of Rs 1,996 crore. New demat accounts opened with NSDL and CDSL in the first six months of 2010 have increased just 6% since the beginning of 2010. Although new accounts are added every month, only 40 to 45% of these accounts end up being active. The total active demat accounts stood at 160.89 lakh as on December 31, 2009 and at 170.3 lakh as on June 30, 2010.

The top five mutual fund houses (in terms of AUM) account for 68.6% of the total complaints received against fund houses. UTI Mutual Fund, ICICI Prudential Mutual Fund, and Birla SunLife Mutual Fund received 64.06% of the 3.94 lakh investor complaints made in 2009-10. UTI Mutual Fund, which holds the largest number of folios (20%) in the country, also accounts for the largest number of complaints received (around 25%). The reverse is the situation in the case of ICICI and Birla SunLife which account for 14.63% and 24.22% of the complaints but account for 5.40% and 4.86%, respectively, of the total folios in the industry.

Piquant Parade

Nomura Asset Management entered into an agreement with LIC MF to acquire a 35% stake in it. In the new joint venture called LIC Nomura Mutual Fund, LIC, LIC Housing, and Nomura will hold 45%, 20%, and 35% stake respectively. LIC will continue to be the sole sponsor of the fund.

UTI Mutual Fund, in association with its mobile solutions partner, mCheck, launched 'UTI Mobile', was the first to enable an investor to initiate payment instructions for investing in mutual fund schemes (currently only UTI Mutual Fund units) from a mobile phone. To avail this facility, an investor would have to initially fill in the registration form and submit the same to any of UTI Financial Centres or Karvy offices. After verification of ECS details, the investor would receive a confirmation subsequent to which he could trigger payment instructions from his mobile phone.

Manulife Asset Management (Hong Kong) Ltd. and Kotak Mahindra (UK) Ltd. have agreed to collaborate with respect to fund management and distribution opportunities in Asia. Under the arrangement, Kotak will get access to Manulife's Asian and global investment capabilities. It will also create cross-distribution opportunities for both companies in the institutional and retail wealth management arenas.

Oriental Bank of Commerce, with its wide-spread network of 1533 branches and very strong base of 1 crore current and savings account customers, has formalised its tie-up with SBI Mutual Fund. The customers of Oriental Bank of Commerce would now be offered mutual fund investment products from SBI Mutual Fund. The wide-spread distribution and reach of Oriental Bank of Commerce across the country, holds the key to achieving maximum penetration and reaching out to a new customer base.

Stock Holding Corporation of India (SHCIL) has rolled-out a new service that provides an avenue for subscription and redemption of mutual fund units through the BSE Star platform in demat mode. As per regulatory requirements, clients desiring the new service will have to execute necessary KYC documents and have a demat account.

Regulatory Rigmarole

To bring greater transparency in the fee structure and improve turn-around time for customer service processes, SEBI has amended four mutual fund regulations and omitted one schedule. These regulations pertain to offer period, allotment of units, refund of excess subscription, account statements, and management fees chargeable by the asset management companies. The offer period for ELSS has been brought down by 30 days. ELSS will now be open for 15 days instead of 45. Fund houses are now expected to refund excess subscription money within five working days instead of six weeks. A failure to do so would start attracting penal interest at 15% p.a. on the expiry of five working days. Prior to July 29, 2010, AMCs were entitled to charge an additional 1% or less management fees in the case of no-load funds. This schedule has now been deleted. Fund houses should cap the management expenses at 0.75% and fix their own fee for administrative expenses, provided the total charge does not exceed 2.5% of the daily or weekly average net assets. The total expense, including management fees, charged from investors in a fund-of-fund scheme should not exceed 0.75% of either the daily or weekly average net assets. In the case of an index fund scheme or exchange traded fund, the total fee charged from an investor, including the investment and advisory expenses, should not exceed 1.5% of the weekly average net assets.

To restrict mutual funds from giving misleading data of their performance to investors, AMCs have been asked to follow a standard set of norms. Notably, mutual funds have been asked to benchmark the performance of their schemes with that of either the Sensex of the BSE or the S&P CNX Nifty of the NSE. At present, most mutual funds measure the performance of their schemes with that of the respective sectoral indices.

Having already hiked the registration fees ten-fold (one-time distributor registration fees to Rs 5,000 from Rs 500 and the renewal fees to Rs 2,500 from Rs 250), AMFI is now likely to tighten ARN registration and renewal norms from September 1, 2010.

SEBI has extended the implementation of application supported by blocked amount (ASBA) in NFOs from October 1, 2010 instead of the earlier directed July 1, 2010. The board introduced ASBA for retail applicants in public issues in September 2008 and institutional investors in April 2010 to bring down the time taken for initial public offers.

AMFI has asked all AMCs to make KYC norms mandatory for all non-individual and NRI investors irrespective of the amount of investment with effect from October 01, 2010. These categories will include corporate, partnership firms, trusts, HUF (Hindu undivided family), NRI, and investors coming through channel distributors. However for individual investors, a decision would be taken only after feedback from SEBI.

SEBI has modified investment limits in derivative instruments for mutual funds as well as the manner of disclosure of these investments. The regulator has stipulated that the cumulative gross exposure in equity, debt, and derivatives positions should not exceed 100% of a scheme's net assets. The option premium paid has been capped at 20 per cent of a scheme's net assets. Cash and cash equivalents with less than 91 day maturity have been deemed as `no exposure' as these are highly liquid positions akin to cash. SEBI has also suggested a proforma for disclosure of both hedged and non-hedged derivatives positions for mutual funds reporting half yearly portfolios. The new norms will be applicable for all new schemes launched after the issue of the circular. All existing schemes should comply with the norms by October 01, 2010.

AMFI has asked fund houses not to accept third party payments effective November 15, 2010 except in the case of payment by “parents/grand-parents/related persons on behalf of a minor for a value not exceeding Rs 50,000, payment by employer on behalf of employee under systematic investment plans (SIP) through payroll deductions, and custodian on behalf of an FII or a client. However, AMCs should obtain mandatory KYC and necessary declaration for investor and the person making the payment. Declaration by the person making the payment should give details of the bank account from which the payment is made and the relationship with the beneficiary. It has also asked AMCs to verify the source of funds to ensure that funds have come from the drawer’s account only.

SEBI has directed that new folios (mutual fund accounts) will be opened only after ensuring that all investor-related documents, including account opening documents, PAN, KYC, Power of Attorney (if applicable), specimen signature are made available with AMCs or the Registrar and Trade Agents, and not just with the distributor of mutual funds by November 15, 2010. In addition, SEBI has directed that the trustees of mutual funds submit a confirmation after they receive certification from an independent auditor, on completion of the process, latest by November 22, 2010.

SEBI may not accept the recommendation to raise the minimum net worth of AMCs from Rs 10 crore to Rs 50 crore. There could be a partial rise in the eligibility criteria since smaller and niche fund houses may find it difficult to meet this norm.

SEBI has proposed biometrics based know your distributor (KYD) norms for independent financial advisors to ensure that details such as address, ARN (AMFI registered number) etc. about fund distributors are known to the industry and also to ensure that persons appearing for mutual fund certification examinations are genuine. Fund houses have been given six months to verify their existing distributors' lists. After implementation of the KYD norms, there will be an 'in-person' verification of each distributor at the time of empanelment. This will bring in complete authenticity of the person(s) dealing with the end client.

In order to facilitate transferability of units of mutual funds held in one demat account to another demat account, SEBI has asked all AMCs to clarify through an addendum that units of all mutual fund schemes held in demat form shall be freely transferable. Mutual fund schemes prohibit transfer on a regular basis instead of on an exceptional basis.

The regulator wants to make sure that fund houses are not distributing commissions from investors’ pockets. Money stored in the load account should be utilised for investors' benefit like investor education programmes and not to pay commission.

SEBI has suggested that profit sharing/performance related fees shall be charged on the basis of high water mark principle over the life of the investment in Portfolio Management Scheme (PMS). The high water mark principle means that if the portfolio value goes down and then recovers, the manager does not earn a fee till all losses have been made up. At present, profit sharing/performance related fees are usually charged by portfolio managers upon exceeding a hurdle rate, or the minimum amount of return that a person requires before making an investment, as specified in the agreement. Once the portfolio rises to a certain peak and the portfolio manager charges fee for it, the next time he could charge a fee only if the portfolio value is above the previous peak and the frequency of charging performance fee should not be less than quarterly. In case of partial withdrawal of funds by investors, all fees and charges should be charged proportionately and the high watermark should be adjusted accordingly. The client is required to separately sign the annexure on fees and charges and add in his own handwriting that he has understood the charge structure. This proposal is in line with global standards of 2+20; two per cent as management fee and 20 per cent as performance incentive.

SEBI has recommended doubling the investment limit prescribed for defining a retail individual investor in a public issue from Rs 1 lakh to Rs 2 lakh, asked all media houses to disclose their investments and private treaties in companies that are the subject of stories, editorials and other forms of reporting, including television, allowed investors to transact in securities through their GPRS-enabled mobiles or wireless internet devices such as laptops with data cards, if they have an online trading account with their brokers, introduced smart order routing to enable investors choose execution destinations based on the best price, costs, speed, likelihood of execution and settlement, size, and the like and hiked the fees charged for the compulsory arbitration mechanism at stock exchanges drastically.

After much deliberations and discussions, the government has settled for a much milder version of the direct tax code (DTC). The new tax law proposes to increase the income tax exemption limit from Rs 1.6 lakh to Rs 2 lakh. For senior citizens and women, the exemption limit is Rs 2.5 lakh. The new tax slabs as proposed by DTC is 10% for incomes from Rs 2 lakh to Rs 5 lakh, 20% for Rs 5-10 lakh and 30% for income over Rs 10 lakh. Tax on wealth over Rs 1 crore will be 1%. The final draft (as approved by the Cabinet) continues with the tax deductions under Section 80 (C) of the existing Income Tax law. The new code proposes a 30% corporate tax from the existing effective rate of 33.22% on account of cess and surcharges. The DTC seeks to impose a minimum alternate tax (MAT) of 20% of the book profit against the existing 18%. The direct tax code is likely to be implemented from April 1, 2011.

Boston Consulting Group (BCG) and CAMS have come up with a report which effectively busts some popular notions that IFA assets are stickier than bank assets, retail investors always get their hands burned by investing at market highs and redeeming in panic in subsequent corrections, banks and NDs are squeezing out the IFA segment, banks and NDs were the major beneficiaries of the AUM transfer mania that the industry witnessed in early 2010 and mutual fund penetration into smaller towns remains a pipe-dream. At the very least, the industry must aspire to match the penetration of retail stock broking if not insurance. If investors in small towns can buy direct equities, why can't advisors and AMCs get them to buy equity funds? That is the immediate challenge for the mutual fund industry.