FUND FULCRUM (contd.)

September 2019

Investor education through digital platform has gained more traction in the past three months compared to ground level programs in the past couple of years. While most AMCs have dedicated portals to educate investors, others are running social media campaigns to promote mutual funds. These digital campaigns focus on educational articles, infographics and videos on their website. In order to reach out to a bigger audience, a few AMCs have launched these campaigns on Twitter and LinkedIn too. Aditya Birla Sun Life, IDFC and UTI are among the more active and creative lot on the digital front. UTI Mutual Fund has a website dedicated to investor education initiative called ‘UTI Swatantra’. The website has a series of educational videos to connect with investors. These videos explain financial jargon related to investments like fiscal deficit, liquid funds, mutual funds and SIP through cricket and Bollywood. UTI has recently released content in regional languages to reach out to a wider audience. Similarly, Aditya Birla Sun Life Mutual Fund has come out with a series of animated videos in regional languages. The idea is to make learning of financial concepts easy and fun for investors. Millennials and women are among the top visitors on videos and podcasts created for investment education. Another way to reach out to investors is through games. IDFC MF has recently launched a game called ‘Game of life’ where participants manage their finances and goals through virtual money. The game puts participants in different circumstances and records their responses to these circumstances. At the end, participants come to know if they have managed their finances well and achieved their financial goals. AMCs are constantly adding features to the investor education website.

Regulatory Rigmarole

AMFI has clarified that PAN is mandatory for mutual funds redemption. With this, PAN exempt folio holders will have to update their KYC details with PAN to redeem their investments from mutual funds. In 2012, SEBI allowed investors to invest up to Rs 50,000 annually in a single mutual fund per year without a permanent account number (PAN). This has come after the recent SEBI inspection of mutual funds in which the market regulator observed that a few AMCs/RTAs have processed redemption requests in respect of non-PAN exempt folios without obtaining the PAN, which is not in line with various SEBI circulars. AMFI said, “It is clear that PAN is required for redemption / repurchase transactions as well in respect of non-PAN-exempt folios, and AMCs/RTAs will be required to collect the PAN of the unitholder(s) at the time of redemption in such cases, if the same has not been provided previously. In short, the redemption transactions received without PAN in respect of non-PAN-exempt folios are liable to be rejected.” AMFI has urged distributors to update PAN details of their clients immediately. AMFI said that the mutual fund industry has 99 lakh folios without PAN as on May 31, 2019.

Mutual funds can now use Aadhar-based KYC to on board investors. This can be seen as a continuation of the government’s proposal in Union Budget 2019-20. The government had proposed to make PAN and Aadhaar interchangeable. While PAN has a concentrated existence, Aadhaar has a widespread presence with 120 crore Indians. Therefore, this move will certainly ease the KYC process and can be a huge boost for mutual fund penetration. However, there is no clarity if the mutual funds can onboard new clients through eKYC. Earlier, an investor could invest up to Rs.50,000 per financial year per mutual fund using OTP based eKYC. Those who wished to invest more than this limit needed to undergo IPV or biometric based authentication at point of service of CAMS and AMCs. Through Aadhaar based eKYC, turnaround time and paper work used to be lesser than usual.

In a move that could help the super rich investing in mutual funds, direct equity, PMS and AIFs, the government has withdrawn enhanced surcharge imposed on super rich only to the extent of LTCG and STCG arising out of transfer of equity shares or units. Earlier in the Union Budget, the government had imposed higher taxes for individuals who earn more than Rs. 2 crore a year. For individuals with taxable income between Rs.2 crore and Rs.5 crore, the surcharge (charged on top of the applicable income tax rate) was increased from 15% to 25%. The government has also increased surcharge on individuals with taxable income of over Rs.5 crore a year to 37%. With this, the effective tax rate for these two groups stood at 39% and 42.74%, respectively. Before the budget, individuals having income between Rs.50 lakh and Rs.1 crore had to pay surcharge of 10% and investors having income of Rs.1 crore and above were paying surcharge of 15%. These tax slabs were applicable to both regular and special income. While regular income includes income from salary, business income or house property, special income takes into account income from long term capital gains or short term capital gains from investments such as mutual funds, equity and fixed income. With the latest announcement, individual having special income will have to pay surcharge of 10% and 15% for income between ‘Rs.50 lakh and Rs.1 crore’ and ‘Rs.1 crore and above’, respectively. However, the relaxation is only applicable to the transfer of units of equity-oriented funds and shares. For instance, if a mutual fund investor books LTCG of Rs.6 crore, he will now have to pay LTCG of 10%+ surcharge of 15%+ 4% cess instead of 10%+ surcharge of 37%+ 4% cess. Simply put, the effective rate of LTCG and STCG on MFs, direct equity, PMS and AIFs, which were increased to 14.25% and 21.37%, respectively, will now be 11.96% and 17.94%, respectively. Equity fund investors have to pay a 10% tax on long-term capital gains above Rs.1 lakh per annum. The LTCG made till January 31, 2018, however, remains grandfathered, i.e., those gains remains tax-exempt.

The government announced reduction in corporate tax rate from 30% to 22%. Including surcharge, the effective tax rate has been reduced from 34.9% to 25.2%. A special 17% rate for new companies starting new manufacturing facilities from October 2019 has also been created. Companies have the option to go for a lower rate or stick to the current rate of 30% if they want to continue to claim exemptions under the Income Tax Act and can move to the lower rate once the exemptions expire. The minimum alternate tax rate has been slashed from 18.5% to 15%. Moreover, government announced that the enhanced surcharge introduced in July 2019 Budget should not apply to capital gains on sale of equity share, which is subject to Securities Transactions Tax (STT). 

Tightening the norms for mutual funds, markets regulator SEBI made it mandatory for liquid schemes to hold at least 20 per cent in liquid assets like cash and government securities in the wake of recent credit crisis. In case, the exposure in such liquid assets falls below 20 per cent of net assets of the scheme, the AMC will have to ensure compliance with the requirement before making any further investments. The new rule, applicable from April 1 2020, is aimed at improving risk management and ensuring sufficient liquidity, SEBI said in a circular. Besides, SEBI said that an AMC will not be permitted to charge investment management and advisory fees for the parking of funds in short-term deposits of scheduled commercial banks. This norm will be applicable after a month. Further, the regulator also barred liquid and overnight schemes from investing in short-term deposits, debt and money market instruments having structured obligations or credit enhancements facilities. However, debt securities with government guarantee will be excluded from such restriction. This rule "shall be effective for all fresh investments with immediate effect" and existing investments in this regard shall be grandfathered", SEBI said. "Mutual Fund shall levy exit load on investors who exit the liquid fund within seven days of their investment. The same shall be effective for all fresh investments from 30th day from the date of this circular," Sebi said. The requirement to levy exit load shall not be applicable to any investments made in liquid funds before the prescribed date. To ensure uniformity across the industry, industry body AMFI has been advised to prescribe the minimum exit load in a liquid fund on a graded basis in consultation with SEBI. The cut-off timings for applicability of Net Asset Value (NAV) in respect of purchase of units in liquid and overnight funds will be 1:30 pm instead of the existing 2:00 pm.

Come April 1, 2020, liquid funds will become more volatile and at the same time safer. In its latest guidelines, SEBI has introduced new valuation metrics to be followed by AMCs. Among the key changes is the introduction of mark-to-market valuation for all debt securities, irrespective of their maturity. The market regulator has asked fund houses to follow waterfall approach for valuation of money market and debt securities irrespective of their maturity. Currently, credit rating agencies follow waterfall valuation approach for debt securities having maturity of over 30 days. Under this approach, while rating agencies consider 1-hour trading volume to arrive at valuation of government securities like g-sec and T-bills, they take into account the trading volume of entire day to arrive at valuation of other debt papers like CPs and CDs. Once they arrive at these valuations, they send the weighted average price of these securities along with the last traded price of these securities to a polling team, which has 25 members from various institutions including banks, mutual funds, insurance and pension funds. Based on the poll, rating agencies decide if a security is valued at weighted average price or its last traded price. Now with the latest regulations, fund houses will have to follow this approach for securities having maturity of less than 30 days too.

Currently, fund houses broadly follow three metrics to arrive at NAV in a liquid fund

·         For a portion of portfolio having exposure to government bonds like g-sec, treasury bills or state development loans (SDLs), the fund house has to rely on credit ratings agencies

·         For repo, tri party repo (TREPS) and short term deposits, the fund house has to follow internal valuation metrics i.e. amortization based valuation i.e. average yield of such securities divided by 360

·         For other securities like derivatives, CPs, CDs and market linked debentures (MLDs), fund houses have two options – a. amortization based valuation and b. follow valuations given by rating agencies. However, the difference between traded price (amortization based valuation) and price quoted by rating agencies of a security should not exceed 0.025%

However, from April 1, 2020, while the first two clauses remain unchanged, fund houses having exposure to other securities like derivatives, CPs, CDs and MLDs in their liquid funds will have to follow rates or price quoted by rating agencies. This essentially means that liquid fund returns would go down by 5-7 bps as there will be no amortization method to arrive at valuation. Fund managers would not take undue risks to deliver attractive performance in liquid funds. Fund managers will now increase average maturity in liquid funds from 30 days to 45-50 days to outperform overnight funds.

Other key changes announced by SEBI are

·         Fund houses will have to upload NAV of all schemes by 11 pm. Currently, the cut off time to upload NAV is 8 pm

·         Below investment grade would be securities having long term rating of below BBB- or short term rating of below A3

·         A security will be termed default if it fails to oblige principal or interest payment on time

·         Fund houses will have to declare their exposure to below investment grade papers

·         Inter scheme transfers (ISTs) will be allowed only if AMCs seek prices of IST from valuation agencies subject to a specific turnaround time

AMFI has modified its due diligence process asking distributors to now give additional details like customer complaints and pending KYC details. The new due diligence process seeks details on nature of complaints received by distributors over the last three financial years i.e. from FY 2016 to FY 2018. Among the key areas of nature of complaints are non-receipt of statement of accounts, discrepancy in statement of accounts, wrong switch between schemes, unauthorized switch between schemes, deviation from scheme attributes, non-updating of email, mobile no, bank details, non-receipt of redemption proceeds, non-receipt of dividend and mis-selling or wrong scheme sold. Distributors are required to share the status of the resolution i.e. how many complaints have been resolved and pending with AMFI. Another modification is seeking details of clients who have not completed KYC, non-PAN folios and FATCA non-compliant accounts. Currently, distributors who have a  presence in more than 20 location or AUA of Rs.100 from individual investors or earn commission of Rs.1 crore and above a year or commission of Rs.50 lakh from a single fund house have to do due diligence under AMFI norms.

NRIs are increasingly taking part in India’s growth story through mutual fund route. NRI Investments in Indian mutual funds now account for nearly 4% of the industry’s total AUM, according to the RBI’s ‘Survey of Foreign Liabilities and Assets of Mutual Fund Companies’ for FY 2018-19. Of the total AUM of Rs.25.50 lakh crore, NRIs’ investments accounted for Rs.93,500 crore as on March 2019. The value of NRIs’ investments in Indian MF industry was Rs.86,000 crore a year ago. Among NRIs, the UAE (16%), the UK (9.6%) and the USA (8.3%) were the largest investors in the Indian MF industry. These three regions account for one-third of the MF units held by all NRIs. While NRIs from most countries increased their investment in Indian MFs, units held by non-residents of Mauritius and Singapore declined. This was following the amendment of Double Taxation Avoidance Agreement (DTAA) with these countries, according to the central bank survey. To put this NRIs’ investment number into context, not all of the 44 Indian MF companies accept investment from NRIs. In fact, only around 8-10 fund houses accept investments from NRIs residing in the US and Canada. This is because of the cumbersome compliance requirements under Foreign Account Tax Compliance Act (FATCA). Under FATCA, it is compulsory for all financial institutions to share the details of transactions involving US citizens, including NRIs with the US Government. Moreover, even among the fund houses that allow NRIs to invest in their schemes, there are some restricting conditions. While some fund houses allow investments only through offline transaction with additional declaration signed by the client, a few fund houses allow clients from US and Canada to invest in close-ended funds.

The Rs.25 lakh crore MF industry requires 4 lakh new ARN holders to achieve Rs.100 crore AUM in ten years, says a report released by AMFI and BCG titled ‘Unlocking the Rs.100 Trillion Opportunity’.

Here are some key findings of the AMFI-BCG report

·         Indian MF industry’s AUM growth outperformed global peers between 2007 i.e. before the economic meltdown and 2018. While most major economies like North America, Europe, Asia (excluding India) and Middle-East and Africa saw many ups and down in their AUM, Latin America and India witnessed a consistent growth in their AUM

·         Globally, India ranked 17 in the asset management industry based on AUM. Interestingly, India has surpassed China in its penetration as a percentage of GDP

·         Contribution from B15 cities increased by 34% in the last three years. As on March 2018, the industry had 25% of assets coming from these cities

·         Mutual fund was the fastest growing financial asset. Over the last four years, household contribution towards mutual funds grew from 3% to 6%. However, small savings like FDs, RDs, direct equity and insurance contributed to a larger portion of household financial savings. Currently, financial savings is 60% of the total household savings

·         MFs accounted for 16% of the total debt market as on March 2018. It was just 3% in March 2012

·         Contribution of top ten fund houses to the overall AUM in India was 83%. This number in US was 62%, UK 47%, China 46% and Brazil 92%.

·         Individual investors i.e. retail and HNIs accounted for 58% of the industry AUM. A major portion of their assets or 65% was in equity funds

·         The proportion of equity assets to the total AUM was 45%. Globally, only the US was ahead of India in such an asset mix. US had 54% of its assets in equity followed by UK and India at 45% as on March 2018

·         IFAs and NDs accounted for 55% of retail assets and 40% for HNIs

·         MF penetration in households was 7% in India

·         There were 10% households having annual income of Rs.10 lakh and above, 37% with annual income between Rs.3 lakh and Rs.10 lakh and 53% with less than Rs.3 lakh

·         Percentage of wealthy households would go up to 17% (over Rs.10 lakh income) and middle income group 46% (Rs.3 lakh and 10 lakh) by 2025

·         To achieve Rs.100 lakh crore AUM in 10 years, the MF industry needs 10 crore investors, 5 lakh distributors and 50% of industry’s assets should be in equity funds

·         Mutual fund, SIP calculator and SIP were the most searched keywords on google

·         Of the total google searches, 38% of users were from B15 cities

·         After ‘MF Sahi Hai’ campaign, the industry added over 50 lakh new investors within 12 months

·         Only 9% of first time investors came to know about mutual funds through IAPs. On the other hand, 40% of first time investors came to know about mutual funds through friends, family members and CAs

India has 37% households having an annual income between Rs.3 lakh and Rs.10 lakh. This population is set to increase to 46% by 2025. For India’s MF industry to reach Rs.100 lakh crore AUM with an investor base of 10 crore in next ten years, tapping the aspiring Indian middle class will be crucial. Currently, the Indian MF industry has around Rs.25 lakh crore AUM and an investor base of 2 crore, says an industry report by AMFI and BCG. Among the ways, which the report noted for expanding coverage to middle-income households, is simplification of the current products. The MF industry offers over 2000 schemes, ranging across asset classes, strategy and risk return profile. Moreover, the industry is laden with complex jargon around product strategies, expense ratios and returns. This difficult jargon along with the wide range of product offerings and extensive KYC paperwork often discourages first time investors from switching from the simple traditional investment products such as bank deposits. To overcome such challenges, the report suggested global examples of ‘solution or goal oriented’ offerings. Some AMCs are already offering benefit-linked MF offerings such as linkages with insurance and medical payment. Further, the report said that the current onboarding processes need to be simplified. Extensive KYC paperwork often discourages first time investors from switching from the simple traditional products. The report suggested standardization of KYC norms across CKYC, KRA, eKYC. It also pitched for digitization of RTAs, which will enable seamless on-boarding experience and better customer engagement. The relatively low share of debt mutual funds means there is significant headroom for penetration. Currently, share of debt mutual funds is less than 25% in individual investors’ AUM. A focused awareness campaign may be needed to highlight the benefits of debt-oriented funds vis-à-vis other debt investment products like fixed deposits. Simplifying debt is of paramount importance.

It is indeed heartening to note that Indians are increasingly moving away from physical savings to financial savings. However, the realization that to beat inflation they will have to change from traditional saving options to equities and mutual funds is happening at a much slower pace. While AMFI’s investor awareness campaign, ‘Mutual Funds Sahi Hai’, is a step in that direction and has met with encouraging success, we are preparing for a concerted strategy that would over time help the saver community across the country to gradually depart from traditional and financially-inferior ingrained attitudes and habits.