SEARCH

Mutual funds must invest in transparency

print   ·  

A large body of investors may want to take advantage of a high equity market via the mutual fund route. But with the operations of the funds not wholly transparent, people may be investing blind. This needs to be remedied. Communication and transparency would greatly enhance the value of mutual funds as an investment avenue, lend credibility to the promoting firms, and engender an environment for systemic stability, says A. Vasudevan.

A. Vasudevan

AS EQUITY prices zoom up, there is an expectation that mutual funds would help investors not conversant with the working of the capital market to given them returns that are higher and safer than any other alternative asset.

The tax break on dividends also seems to have helped the mutual funds industry to grow. In addition the soft deposit interest regime actively promoted by the policy-makers has tended to give an edge to mutual funds in terms of rates of return.

There are over 30 mutual funds in India with assets worth over Rs 1,50,000 crore. Some of the mutual funds have tie-ups with their foreign counterparts.

There are also many bank-sponsored funds. All of them work actively to help get business through a battery of means canvassing through phone calls, brochures, or even personal visits.

Almost all mutual funds offer more or less the same type of schemes or products. They, however, carry fancy names such as equity fund, GenNext fund, debt fund, flexicap fund, growth fund, liquid fund, systematic investment plan, income fund, dividend yield fund, infrastructure fund, and funds that link savings and at times with insurance.

The literature on each scheme contains information about net asset value (NAV) and dividend payouts which most ordinary investors do not comprehend as the explanations are not exactly in the simplest language.

The offer documents are often bulky with a good bit of jargon thrown in for effect. The market participants are well aware how such terms as `initial public offering' and `at par issue' have been misused in recent months, justifiably incurring the displeasure of the Securities and Exchange Board of India (SEBI).

Questions now are whether the current upswing of the equity market will sustain and whether mutual fund firms will be able to deliver what they seem to promise. Set in this context, it is necessary to appreciate the critical importance of investor protection.

This would imply that communications by mutual funds to investors are easily comprehensible to ordinary investors.

While all the mutual funds put out cautionary notes that investors should go through their schemes and assess the risks before deciding to invest, they are perceived essentially as a defence mechanism of the industry to protect itself from any legal backlash.

Ordinary investors, it is well recognised, are often influenced by the kind of advertisements and hand-outs that mutual funds put out and by the atmospherics generated by exaggerated media accounts of high capitalisation in the equity market. This group of investors rarely looks into questions of the operations and efficiency of transactions of mutual funds to determine as to which they should invest in.

In fact, in their own interest all investors in mutual funds should focus on a number of issues relating to the industry. But equally, or more, important is for mutual fund firms to fashion their communication and transparency practices to meet the international standards.

The issues of concern are, for example, the criteria that fund managers use to diversify the investment portfolios; the divergence between the total return that an investor would get in the equity market due to capitalisation and dividend yields and the net return that mutual funds give on the their schemes; the expenses incurred by mutual funds for their operations; the proportion of large investor and institutional holdings in mutual funds; and the arrangements within the mutual fund organisations to comply with the statutory requirements.

These issues are not, however, necessarily mutually exclusive. The fund managers could change the proportion of their investments in different asset types but not the entire portfolio composition without prior intimation to the investors.

sOne would expect the fund managers to change the asset composition when they find that some of the existing assets are not sufficiently remunerative and risk-less compared with their proposed investments.

But whether this judgment is based on appropriate weights being given to both the remuneration and the risk factors, or on instrument ratings remains unknown to investors.

Nor is it clear whether there is a pattern of harmony if not collusion of decisions about changing the asset composition by the mutual fund managers.

The decisions may not also be time-consistent. All that the investors would know is the asset composition and the extent of change in it.

This begs the question as to whether the gains from investing in mutual funds would equal that from capitalisation of equity shares when the equity market is on an upswing. If the latter is higher and the wedge has widened, either the fund managers and their analyst-teams are risk averse, or the expenses of the mutual fund firm have gone up.

If it is the latter, on account of the hikes in the overall benefits granted to the employees, there could be questions about the interests of the investors.

Is this a possibility in the Indian context?

It is widely believed that employment of business management and information technology graduates to executive positions at different levels by mutual fund organisations at relatively high salaries and other benefits has helped improve the total remuneration of the non-executives as well. This has forced many public sector organisations to improve the extent of overall benefits of their employees so as to retain the best of their personnel.

If this impression is correct, periodic examination of the pattern of expenditures of mutual fund firms would be necessary to appreciate as to whether the widely prevalent practice of the executives improving their real incomes in countries such as the United States is also in existence in India.

This is particularly pertinent if the mutual funds should improve the efficiency in the allocation of scarce investible resources and not jeopardise the existing income distribution in the organised sector.

The institutional and large investors form a significant proportion of the business of mutual funds but little is known as to why they prefer certain mutual fund firms and not others.

Surveys conducted on sound methodologies about the factors that large and institutional investors reckon in selecting mutual funds in general and certain mutual fund firms in particular, as their investment choice are not many.

But such surveys should be made frequently and widely publicised so that the confidence of ordinary investors in mutual funds would be fostered on an enduring basis.

Further, mutual fund firms would need to publicise the arrangements in place for complying with the regulator's guidelines.

The compliance chief should be drawn from outside the organisation on contract for a fixed period and be allowed to function without being overseen by senior executives.

This person should be answerable to the Board of Directors and the Chief Executive Officer but this should not preclude his sending compliance reports directly to the regulator without the CEO's approval.

Communication and transparency on all these issues would greatly enhance the value of mutual funds as an investment avenue, lend a greater degree of credibility to the mutual fund firms, and promote sound environment for systemic stability.

(The author, a former Executive Director of the Reserve Bank of India, can be accessed on asurivasudevan@hotmail.com)

(This article was published in the Business Line print edition dated August 4, 2005)
XThese are links to The Hindu Business Line suggested by Outbrain, which may or may not be relevant to the other content on this page. You can read Outbrain's privacy and cookie policy here.

O
P
E
N

close

Recent Article in OPINION

WTO must prevail over splinter groups

Trade between members of a group affects the rest of the world. Hence the importance of multilateralism »

Comments to: web.businessline@thehindu.co.in. Copyright © 2014, The Hindu Business Line.