Aarati Krishnan

Much ado about mutual funds

AARATI KRISHNAN | Updated on March 10, 2018


Market forces are already doing a good job of putting the chronic under-performers out of business in the mutual fund industry. If SEBI is worried about the few laggards among the fund houses, it must crack the whip on the Board of Trustees.

When U K Sinha took up the baton as Chairman of Securities and Exchange Board of India (SEBI) early last year, it put the mutual funds industry in a celebratory mood.

‘Here, at last, is a regulator who will understand and sympathise with us’ seemed to be the refrain.

It was expected that Mr Sinha, fresh from his stint with UTI Mutual Fund, would immediately set to work sorting out the many grievances of the fund industry.

These ranged from the peremptory ban on entry loads imposed by his predecessor to the lack of a level-playing field with Unit Linked Insurance Plans (ULIPs).

Tightening the screws

About one-and-a-half years into the job, however, Mr Sinha has done no such thing. Far from being a benevolent regulator who would bat for the industry, he has introduced new amendments that tighten the screws on them (and rightly so!).

These dictate everything from how mutual funds should advertise their performance to how they must conduct due diligence on their distributors. The ban on entry loads, of course, remains.

But SEBI’s latest salvo on mutual fund performance appears to be a case of taking such regulatory zeal too far. At a recent industry summit, Mr Sinha set the cat among the pigeons by stating that the SEBI intended to question the CEOs and fund managers of fund houses that nursed chronic under-performers. These schemes would then be pushed to consolidate or merge.

Now, the SEBI Act does task the market regulator with the onus of investor protection. But given that SEBI’s role extends across not just mutual funds but also to equity, bond and other markets, this has to be interpreted in terms of preserving market integrity and reducing systemic risk for investors.

Ensuring the health of the industry by delving into individual fund returns and interrogating fund managers seems to be a case of avoidable micro-management. Especially for a regulator who is already under-staffed and over-burdened.

A regulator needs to worry about the individual constituents of the sector it oversees only if it perceives structural issues that threaten the health of the industry.

No such structural problems are evident in the case of mutual funds. Indeed, by SEBI’s own admission, over three-fourths of mutual funds have outperformed their benchmarks over a long timeframe.

Market forces at work

What is more, in the fund industry, market forces are already doing a good job of putting the chronic underperformers out of business.

The perpetual exit window provided by open-end funds, taken with good disclosure norms and third-party ratings, have ensured that fund managers are already kept on their toes by investors.

Trends in fund flows over the past five years clearly show investors pulling monies out of the poorly performing funds and making a beeline for consistent benchmark beaters.

That is indeed why JM Mutual Fund, with many of its equity funds lagging benchmarks, has less than Rs 1000 crore of equity assets in its fold today, while the consistent HDFC Mutual Fund has Rs 38,000 crore of assets.

Wake-up call for trustees

One is not suggesting here that fund houses which consistently botch up their performance and serve up lemons must be allowed to go scot-free.

In these cases, it is the fund’s Board of Trustees who must exercise the necessary authority to pull up and, if necessary, replace the investment managers.

It is precisely to oversee the performance of a fund at the scheme level that Indian laws require mutual funds to be set up as a three-tier structure.

In this structure, the trustees of a mutual fund have a fiduciary duty to ensure that the fund and its personnel not only comply with the necessary regulations, but also deliver on the fund’s stated objectives to investors.

SEBI’s Mutual Fund Regulations arm trustees with extensive powers to verify whether the fund management company has the right personnel, risk management systems, back office and auditors in place.

To ensure that the Board of Trustees is indeed effective, law requires two-thirds of the trustees to be independent and forbids overlaps between the sponsoring company, the asset management company and the trustees.

Whether trustees of Indian mutual funds indeed take these responsibilities seriously can certainly be questioned, though.

The fund industry does nurse its share of consistent laggards. But in the three-decade history of Indian mutual funds, there has not been even a single instance of a trustee company replacing a fund’s investment manager either for sharp practice or poor performance.

This suggests that the best way for SEBI to ensure that underperforming funds get their act together, without getting into the nitty-gritty of individual schemes, would be to crack the whip on their Board of Trustees.

SEBI can seek greater accountability from and impose penalties on trustees who oversee funds.

Having said all this though, one industry where the regulator may need to take a leaf out of SEBI’s books would be insurance.

The insurance industry today manages even more investor money than mutual funds.

But insurance products are far from transparent and there are also no independent agencies or portals that allow investors to benchmark or regularly monitor the performance of the insurance products they own.

Unlike mutual funds, investors in insurance products are often locked in for at least a five-year term and penalised for early exit.

With investors having no power to vote with their feet, here is a case for the regulator (IRDA in this case) to worry over performance details.


Published on July 01, 2012

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