The Hindu Business Line : Equity rush

MONEY HAS BEEN pouring into equity mutual funds in recent months, suggesting that small investors are taking to the bourses. Yet, this is no clear evidence that they are really comfortable with equity. For the bulk of the recent flows has been to the initial public offerings for new products, rather than to established funds that have successfully weathered market ups and downs. Since these offerings are made at par, investors seem to believe that the downside risk is minimal. But that is far from the case, and any disenchantment on this count could turn investors away from equity.

It is also not a good sign that the flows into equity funds are refusing to break out of the pattern repeatedly seen in the past. Investors are pouring in money after the average equity fund has doubled in value in a couple of years. As a result, fund houses have ended up with substantial fresh money in their coffers, when conditions are less-than-ideal for investing. There have been reports in recent months of fund houses sitting on mounds of cash, which they are waiting to deploy at more attractive valuations. Then, there is the evidence that some investors are punting on the new funds, just as they do with newly-listed stocks. This creates serious upheavals in fund management and lowers returns for long-term investors in equity funds.

The fund industry has to shoulder a good portion of the blame for encouraging such practices. Fund houses seem to be expending too much effort in hard-selling IPOs and too little in disabusing investors of their misgivings about the older, established funds. This, once again, seems to be an instance of the interests of the distributor being allowed to take precedence over those of the investor. One of the reasons why fund houses find it lucrative to promote IPOs, rather than older funds, is in the more liberal spending limits allowed on such launches. While the Securities and Exchange Board of India places a limit of 2.5 per cent a year on the recurring expenses of a running equity fund, new funds are allowed to spend up to 6 per cent of the collections on promotional and other expenses associated with the initial offer. Distributors, thus, stand to earn larger incentives when they market new funds than they do with established ones. Since it is investors who ultimately bear the brunt of these expenses in many cases, the IPOs are turning out to be a shortcut to a larger corpus, and a higher reward for distributors.

SEBI should examine the feasibility of allowing existing funds to pay a higher reward on incremental funds mobilised so that decisions on floating of new schemes are dictated solely by differences in risk characteristics of the portfolio rather than what is beneficial to the intermediaries. While this may bring some sanity to the mad rush to float new schemes, ultimately it is the fund industry that will have to make the difficult choice. The IPOs may lead to a spectacular but transitory boom in the assets managed. On the other hand, promoting regular investments in the established funds will lead to a gradual expansion of the business that will sustain even if the bull market does not.

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