What happens if my fund house goes bust?

What will happen to our investments in case a mutual fund sponsor like Goldman Sachs goes bankrupt, given the recent example of MF Global. I am investing regularly in GS Nifty BeES and gold ETFs.

Rajeev Gupta

You do not have to panic about your fund or your fund house going bust. To provide you some comfort on this, we will discuss briefly the legal framework of mutual funds.

Framework

To begin with, mutual funds are run by asset management companies (AMCs) that earn their income through a fee that is charged on the value of your units. AMCs are neither investment bankers like Goldman Sachs in the US or broker-dealers for futures and options, such as MF Global. Mutual funds simply manage a pool of money from investors in return for percentage fee. The money parked in the schemes of a mutual fund belongs to the investors at all times, and is not mingled with the funds of the AMC.

To ensure that the sponsor of the mutual fund does not have direct access to transactions, the fund house is run as a registered trust, initiated by the sponsor like a Reliance, Kotak or HDFC. There is a body of trustees, with many independent directors, who seek to act in the investors' interest.

Indian experience

While consolidation of fund houses — which involves a sponsor selling the fund-house to another player — has been common in India, there have only been a couple of cases of mutual fund scams or mismanagement of funds in the past.

CRB Mutual Fund (which managed the close-ended Arihant Mangal scheme) was alleged to be involved in a case of diversion of funds by the promoter. The UTI-managed US-64 failed to disclose the erosion in the scheme's NAV, even as it continued to buy back units at a fixed price and paid out dividends.

These events happened in the mid-1990s. Since then, SEBI regulations governing mutual funds have become far more stringent and leave little room for manipulation. Disclosures of NAVs happen on a daily basis, leaving hardly any scope for hiding facts. Fund holdings and their returns against their respective benchmarks are usually disclosed on a monthly basis, giving you an opportunity to exit the fund if you are unhappy with the choice of investments.

Moving to the source of your fear, broker-dealer MF Global made a massive leveraged bet on European sovereign debt that was becoming risky in terms of its creditworthiness. Similarly, during the US financial crisis, investment banking and brokerage firms went bust after their exposure to complex products turned sore.

It is important to know that an AMC business is different from the above.In the event of the winding up of a mutual fund, you will receive your funds back, based on the NAV at the most recent date. Goldman Sachs, at present, has not shown any signs of distress. Besides, the local exchange-traded funds managed by Goldman Sachs are mostly passive funds. To this extent, they have lean costs. Even in the event of the sponsor filing for any bankruptcy in the US, they cannot dip into your funds, which are safeguarded by a trust. The repayment process, though, could take a while.

Poor management

Yes, it is possible for mutual funds to inflict losses on you, due to poor fund management. They may end up taking risky bets, especially in debt instruments and struggle to sell, or receive money from, such instruments. But even here, there are restrictions on the level of illiquid assets (instruments that cannot be easily sold in the market) a fund can hold.

Besides, the regulators here have ensured that retail investors are not exposed to complex structured products, on the lines of those available in the US or Europe.

Diversify

This said, we would prefer that you spread your investments over a few fund houses to avoid getting hurt by any slippage in management of funds by a single fund house. Besides, given that mutual funds in India change hands all of a sudden, a chunk of your money may suddenly move to a fund-house that has no track record or background in India. You can avoid the risks associated with such an uncertainty by holding funds across multiple AMCs. Now that there are other ETFs for gold and other key indices, besides BeES, you can hold one more ETF from another stable. Also, it may not be a very good idea to keep increasing your holdings in ETFs. You will be aware that actively managed funds in India have consistently beaten the indices, even if you look at their track record over a decade. We, therefore, hope you have included diversified mutual funds in your portfolio.

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