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Aarati Krishnan

HOW would you react to the news that over a third of your mutual fund's assets are held by just one investor? Such instances of big-ticket investors holding a significant portion of the NAV of a mutual fund are not uncommon in the Indian context.

That institutions invest heavily in short term debt products managed by mutual funds, is probably well known.

But recent disclosures by funds suggest that even funds in which retail investors would usually invest, such as income funds, floating rate funds, gilt funds andmonthly income plans, may have a load of big-ticket investors. Nor are equity and balanced funds free of such investors.

No comfort from institutions

For an investor in stocks, news that an institution has picked up a stake in the company often enhances the comfort level in holding the stock. But the same may not hold good for your investments in mutual funds. The presence of big-ticket investors in a mutual fund may actually add a dose of risk, on two counts.

One, institutional investors usually churn their investments more frequently than retail investors. This could enhance transaction costs and, in certain circumstances, dent returns for the long-term investors in a fund.

Two, pullouts by institutional investors have greater potential to destabilise fund management, bringing considerable unpredictability to fund management (see bottom story).

As the Indian fund industry has come to depend mainly on institutions and high net worth individuals for critical mass, retail investors may not be able to avoid such risks. But investors can certainly use the signals from the statutory and voluntary disclosures made by funds(see Infographic), to stay away from funds where big-ticket investments pose a particularly potent threat.

Welcome mat for big-ticket investors

Not only does the Indian mutual fund industry lean quite heavily on big-ticket investors for support, quite a few industry practices actually encourage such investors to park their money in mutual fund products for the short term.

Dividend/bonus-stripping: Practices such as dividend and bonus stripping, which attract precisely such investments, are rife, both in debt and equity funds.

Fund houses typically announce the record dates for their dividend announcements well in advance of the event. Investors can enter the fund just before the record date and book a notional "capital loss" on their investment, by selling their units on an ex-dividend basis. This capital loss can then be used to set off capital gains from other sources, thus saving a packet on taxes. The recently launched "bonus plans" in debt funds also appear to serve a similar purpose- investors use the drop in NAV post-bonus to book a notional capital loss on part of their investment.

Though the tax laws have made dividend stripping more difficult by stipulating a three-month lock-in for investments made just before the record date, dividend-stripping still appears to be rampant. The recent bull run in stocks was, for instance, accompanied by a spate of dividend announcements from equity funds. While this may be in order, there is the disturbing practice of funds announcing record dates well in advance of the actual dividend payout. In a recent instance, Birla Advantage, a prominent equity fund, announced record dates for three of its future dividend payouts!

Such announcements are usually followed by a sharp ramp-up in the asset size of the fund as the record date draws close. Such inflows may actually impede a fund manager's ability to manage his portfolio with a long-term perspective.

If the bulk of these "dividend" investors are merely using the fund as a temporary tax-planning vehicle, the fund's asset base could shrink to much the same extent as it expanded, once the three-month lock-in period runs out.

Bigger the investment, lower the entry load: The selling practices of funds also seem to tilt the scales in favour of the big investor. New investors in equity and balanced mutual funds are usually charged an entry load of between 1.5 per cent and 2 per cent of the NAV, towards brokerage and transaction costs.

But over the past year, many fund houses have lowered the entry loads or even waived them, for big investors. The load structure of HSBC Equity Fund is a case in point. While investments of less than Rs 2 crore in the fund attract an entry load of 2 per cent, this entry load is waived for investors who pump in Rs 2 crore or more at one go.

Exit loads waived for large investors: Exit loads are usually good tools to deter short term investments in a fund, but they do not seem to serve this purpose here. In the Indian context, most equity and balanced funds do not charge any exit load.

Debt funds do charge an exit load, but these exit loads too, are waived for large investors. To take just one example, the Alliance Income Fund recently announced changes in its load structure, after which investors who pull out from the fund within six months of investing, pay the penalty of a 0.5 per cent exit load. But this exit load is waived if your transaction size is over Rs 10 lakh!

This appears iniquitous, as a pullout by a large investor in a fund certainly has greater potential to destabilise fund management, than when a retail investor redeems a few hundred units.

Lower costs for institutions: If the load structure puts retail investors at a disadvantage while entering or exiting a fund, retail investors also appear to be on the losing side, when it comes to the recurring expenses charged by the fund. Debt products meant for institutional investors often come with a lower expense ratio, than products meant for retail investors.

What is more, a few fund houses recently unveiled "Institutional" plans within their existing debt funds, which are often charged with a much lower management fee than the regular plan of the same debt fund (see Table).

This may be justified if the portfolios for institutional and retail investors are managed by two distinct fund management teams.

But the portfolio disclosures from the funds suggest that, in practise, quite a few fund houses do not separate the "retail" and "institutional" portions of a debt fund for the purposes of fund management.

That retail investors have to cough an extra management fee of 50 basis points may not appear a major issue now, when debt funds are coming off a period of double-digit returns. But the differential expense ratios could begin to pinch, once interest rates stabilise and debt fund returns drop to levels of 5-7 per cent per year.

Other grey areas: Recent strictures issued by the Association of Mutual Funds of India to industry members suggest that fund houses (or their distributors) may be accommodating their big investors in other ways as well. AMFI recently asked funds and their distributors to refrain from such practices as offering back-dated NAVs to favoured clients and offering "rebates" to big investors in the form of "reimbursement of DD charges".

Such practices may not be widely prevalent, but they are indications that big-ticket investors get preferential treatment when they invest in mutual fund products.

Incidentally, the phenomenon of short-term, institutional investments in mutual funds recently attracted a wave of regulatory attention in US.

Revelations that some of the big names in the mutual fund business have allowed big investors to park their investments with mutual funds, in the process skimming off returns due to the long-term investors, has kindled public outrage, forced a few funds to cough up monetary damages and claimed a few scalps among the top management at some of the US funds.

Both SEBI and AMFI have recently been taking greater notice of the big-ticket investments in mutual funds and the risks that such investors bring to the table. But until concrete regulations emerge to curb such practices, it is up to the retail investor to put in some additional homework, while investing in mutual funds.

Infographics: K. Balaa

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