FUND FULCRUM
March 2012
March 2012
The AUM of equity schemes increased by 3% to Rs. 1.61 lakh crore in February 2012 from Rs. 1.56 lakh crore in January 2012 ably assisted by a 3% spurt in BSE Sensex in February 2012. Equity mutual funds suffered a second consecutive net outflow in February 2012 to the tune of Rs. 2680 crore as against Rs. 456 crore in January 2012 according to the latest AMFI data. Sales from all equity schemes stood at Rs. 3,607 crore, the highest since September 2011 while redemption stood much higher at Rs. 6,287 crore, the highest since October 2010, which resulted in Rs. 2,680 crore net outflows. But for liquid, gold ETFs and fund of funds investing overseas, all other categories recorded net outflows to the tune of Rs. 5707 crore. The total assets under management of the industry went marginally up by 2% from Rs. 6.59 lakh crore in January 2012 to Rs. 6.75 lakh crore in February 2012. In the last 11 months equity mutual funds have seen a net inflow of just Rs 51 crore which is better than last year. For the 11 months last year, equity mutual funds suffered an outflow of Rs 13,591 crore. Despite the huge outflows, sales were much better in the previous period which came up to a total of Rs 61,225 crore compared to the sales of the last 11 months which amounted to just Rs 45,635 crore.
According to the latest statistics from the Securities and Exchange Board of India, as many as 514,000 equity folios were closed, further reducing the retail investors’ base for the struggling mutual fund industry. Taking the latest exodus into account, the financial year 2011-12 has so far seen the closure of 1.4 million equity folios. In 2010-11, the industry had lost 1.8 million equity folios. SIP inflows have declined in December 2011 and January 2012. This trend can be attributed to investors switching their investments to tax-free products with the financial year-end closing in and to the loss of confidence among investors in the market due to the prevailing volatility. According to a leading registrar, new SIP registrations for the month of December 2011 stood at 1.51 lakh, which dropped to 95,272 in January 2012. A lot of investment has moved from SIPs into tax-free products, where the investors are earning 11% returns. They do not want to take risks in equity because they currently lack the confidence in the market. Investors need to understand that SIPs win in the long run.
Piquant Parade
HDFC Asset Management Co. Ltd, and Pramerica Asset Managers Pvt. Ltd, an arm of the US-headquartered Prudential Financial Inc, have emerged as the frontrunners to buy the assets of Fidelity’s mutual fund in India—FIL Fund Management Pvt. Ltd. Out of some 20 bidders, HDFC and Pramerica mutual funds have been shortlisted and their bids are in the range of Rs. 400-500 crore. HDFC and Pramerica’s bids value Fidelity Mutual Fund at 4-5% of its average assets, a sizable amount in light of the AMC’s cumulative losses of Rs. 333 crore. In 2011, its losses more than doubled to Rs. 62.39 crore over the previous year. An interesting income-tax provision plays a key role behind the ongoing Fidelity deal. In normal course, under section 72 of the Income-Tax Act, a mutual fund is allowed to carry forward its losses for eight years. But, under section 79 of the law, this loss is not allowed to be carried forward if there is a change in ownership of the company. If a fund house directly buys the assets of Fidelity MF in India, section 79 of the income-tax law will be triggered and the buyer will have to bear the losses of Fidelity Mutual Fund at one go. This can be avoided through another clause of section 79, which allows losses to be carried forward, post the deal, only if the Indian company is a subsidiary of a foreign company and the change in ownership arises as a result of amalgamation or demerger of the foreign company. The acquirer will not only be able to carry forward the losses of Fidelity Mutual Fund for eight years but also save on taxes till such time its profit gets offset by past losses. For this reason, the bidders are willing to pay a little more than average valuations for an acquisition. Fund house acquisitions are valued on the basis of the asset mix, network strength, long-term earnings prospects and profitability.
Schroders, the UK-based asset management giant that manages close to $291 billion in assets, is set to acquire nearly 30% in Axis Asset Management Company. The transaction will help Schroders revive its India presence and end Axis Asset Management Company’s search for a strategic partner in the mutual fund business. While two other companies had evinced interest in buying a stake in the asset management company promoted by Axis Bank, Schroders is set to seal the deal.
Regulatory Rigmarole
SEBI, the capital market regulator, has announced a change in the advertising code for mutual funds from being ‘rule-based' to ‘principle-based'. Mutual funds will now be required to make fewer disclosures. One of the biggest challenges that fund houses faced earlier was in the disclosure of the risk factors. While the advertisement itself was just four lines long, the risk factors alone would run for 15-20 lines. Under the new regulation, the risk factors would occupy around 40% less of the surface area in case of print ads, and lead to a significant reduction in advertising expenditure. SEBI now mandates that these risk factors will now be replaced by the disclaimer — “Mutual funds are subject to market risk. Please read the scheme-related offer documents carefully.” SEBI has also asked fund houses not to mention fund ratings due to lack of uniformity in awarding these rankings. Only those funds, like the capital protection funds, which require SEBI-mandated ratings, are allowed to mention their ratings in the advertisements. With respect to the audio-visual advertisements, the new regulation re-emphasises the need to be audible and understandable to the viewers or listeners. However, confusion still persists over certain issues. The new regulation forbids the use of ‘slogans' in advertisements. The definition of ‘slogan' remains unclear though.
The National Stock Exchange (NSE) has launched a know-your-customer registration agency (KRA) through its subsidiary Dotex International. The move comes in the wake of specific directive from the Securities and Exchange Board of India to start KRAs. The initiative by SEBI will benefit investors, as their paper work will be reduced and they have the option of going to another intermediary, without repeating the know your customer (KYC) formalities. An investor will not have to repeat the KYC, if he has done it through either a broker or a depository participant, or with an asset management company, to invest in a mutual fund.
SEBI has relaxed the portfolio replication from 100% to 70% in PMS or advisory funds for domestic fund managers. The move spells good news for AMCs managing offshore funds or PMS in India. SEBI has stated that a minimum of 70% of portfolio value shall be adequate, provided that the AMC has in place a written policy for trade allocation and it ensures that the fund manager does not take directionally opposite positions in the schemes managed by him. Instead of two fund managers managing offshore funds, AMCs can have one fund manager running the show. Earlier AMCs were required to have different processes, systems and fund managers for managing offshore funds.
SEBI has clarified that the responsibility of distributors due diligence rests solely with AMCs. It has asked AMCs not to delegate this responsibility to any agency. AMCs can take the help of external auditors to conduct due diligence but the final responsibility rests with AMCs. A majority of the AMCs have agreed with AMFI for appointing common audit firms to kick start distributor due diligence. Meanwhile, AMFI is trying to convince the three remaining AMCs to come on board as well. The cost of the project will be shared among all the AMCs depending on the number of distributors empanelled with a fund house. SEBI’s circular states that the audit should ascertain distributors servicing standards, grievance redressal mechanism, experience, staff training and certification among other things. The due diligence, a part of SEBI’s first step towards regulating mutual fund distributors, will cover the big distributors accounting for a substantial chunk of the industry AUM.
SEBI has given seven months to AMCs to implement the new valuation norms for liquid funds. Under this, the regulator has decided to bring down the threshold for marked to market (MTM) requirements to 60 days from 91 days earlier. The new norms will be effective from September 30 2012.To enhance transparency, AMCs should disclose all details of debt and money market securities transacted in its schemes portfolio on their websites. Fund houses are required to make these disclosures daily with a time lag of 30 days.
The country's mutual fund industry is battling a Rs 500-crore tax demand on interest earnings from some of their earlier investments in securitised papers. In order to pre-empt tax authorities from freezing their bank accounts, fund houses have moved court challenging the order. Leading mutual funds including UTI MF, SBI Mutual Fund, HSBC AMC, Birla Sun Life MF, Reliance Mutual Fund, Religare and Kotak have filed writ petitions, praying for a stay, before the Bombay High Court. Even though mutual funds are exempt from paying tax on their income from investments, the Income tax Department believes that income from securitised instruments, better known as pass through certificates (PTCs) in financial markets, are taxable. The tax claims pertain to assessment years 2007-08, '08-'09 and '09-'10.
The 2012-2013 Budget certainly lacked any big bang wealth creating opportunity as far as the stock markets are concerned. But it did try to do its bit to enhance the depth of the market and pump in more liquidity into the same. Introduced for the first time ever, the Rajiv Gandhi Equity Savings scheme allows for income tax deduction of 50% to new retail investors (approximately 1.5 crore investors). However, the investment is subject to a maximum limit of Rs 50,000 and restricted to investors with annual income of less than Rs 10 lakh. Besides, the scheme also has a lock-in period of 3 years. This move is certainly a precursor to the proposed Direct Taxes Code. To provide a safer environment, investments under the new scheme may initially be allowed only in the top 100 or 200 companies (on the basis of market capitalisation) listed on various stock exchanges. The new scheme is being designed to encourage flow of savings in financial instruments and improve depth of the domestic capital market. The Securities Transaction Tax (STT) on cash delivery transactions has been reduced by 20%, from 0.125% to 0.1%, in order to reduce transaction costs in the capital markets. The budget announced a hike in service tax from 10% to 12%. Fund houses pay a service tax on the assets managed by them, which they used to set off against the service tax paid on distributor commissions. However, with the recent exemption in service tax on distributor commissions they have little leeway to set off such costs.
53% of actively managed equity funds have failed to beat S&P CNX Nifty, a benchmark index for large cap companies according to a CRISIL study. However, in 2011, 65% large cap funds produced higher returns than the S&P CNX Nifty. Similarly about 58% of diversified funds underperformed the S&P CNX 500 over the past five years but in 2011, 54% of diversified funds were able to beat the index. The story is similar for ELSS and balanced funds. MIPs, gilt and debt funds (which invest in corporate debt) on the other hand have outperformed their benchmarks over a five year period. The Indian mutual fund industry is going through a consolidation phase. None of the categories had a 100% survivorship over the past five years indicating mergers across categories. Among funds, diversified equity funds had the lowest survivorship in the one and five-year periods, while balanced funds had the lowest survivorship in the three year period.
