The Hindu Business Line : Route them right

FOREIGN INSTITUTIONAL INVESTORS have of late developed a voracious appetite for Indian equities, which seem to have been only partially satiated. So, their recent move to route investments to India via domestic mutual funds was only to be expected. Allowing institutional investors, especially those with long-term funds, to take exposure in domestic funds may bring several attendant benefits to domestic investors in stocks and funds. But in the larger interest of retail investors, the Securities and Exchange Board of India should ensure that such investments are routed through separate funds, managed specifically for such investors; and not through the existing funds.

With institutional investors coming on board, domestic mutual funds can be expected to tone up their management and investment practices by benchmarking them to global standards. This could mean spin-off benefits for domestic fund investors: From more clearly defined investment strategies, to better risk management practices and, importantly, much lower costs. But there may be a flip side. Allowing the FIIs to invest in the equity funds open to retail investors may do more harm than good to the latter's interests. Already in debt-oriented funds where Indian institutions are heavily invested retail investors have faced a slew of problems. The presence of large institutional investors has resulted in volatile swings in the assets managed by funds. This forces fund managers to resort to frequent trading, which increases transaction costs, or to keep larger sums of monies in near-cash instruments; which can impact returns. There have also been instances where fund managers have resorted to discriminatory practices, to the detriment of retail investors.

Given the size of funds at their disposal and the clout they could carry with domestic fund houses, such distortions can surely be expected in equity funds if foreign investors are allowed in. Apart from making sure that fund houses launch separate products for such investors, SEBI must also formulate comprehensive guidelines to ensure that retail investors are protected from discriminatory practices, when fund houses allocate transaction costs and expenses between products. For the FIIs, this may be a back-door route to taking exposures in stocks where sectoral caps have been hit. Foreign investors are also rapidly running out of headroom in the stocks and sectors that they fancy. For instance, a number of banking stocks closed their doors to fresh FII buying in recent weeks. Such caps may have served a purpose in the initial phase of reforms where there were concerns of foreign capital. With subsequent liberalisation in investment norms suggesting that such concerns were largely misplaced, the process has to be carried forward.

It would also be a welcome development for the Indian equity market if long-term investors such as foreign pension funds use the mutual fund route to invest here. Market participants have often bemoaned the lack of long-term money in Indian equities and cite it as the reason for the high volatility and the lack of depth. Given their long-term orientation and willingness to stick with their investment choices for long periods, inflows from retirement funds would definitely lend a stable underpinning to stock valuations.

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