Mutual funds in the aftermath of October bloodbath

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: October will go down in the annals of the mutual fund industry as perhaps the bloodiest month. The action that was building up in all the asset markets found its way to the mutual funds sector and caused the industry to shiver. Assets under management fell from Rs .29 lakh crore to Rs 4.31 lakh crore, a fall of around 18.37%, or around Rs 97,201 crore, in a month. For some of the smaller funds the erosion was as much as 30%.

Now, this means a lot. First, it means that some players in the industry will not be able to sustain their operations. An asset management company runs on the management fees generated as a percentage of the fund corpus. When the fund corpus or the assets under management shrinks, the funds available to run the business become less. An 18% fall in one month, therefore, means a huge hit. It’s no wonder that the fund house bosses are left with the horrendous job of sacking team mates and in some cases selling off to prospective buyers, as was the case of Lotus Mutual Fund.

On the other hand, the huge redemption pressure meant that the fund houses had to literally take a trip to New Delhi to coax the finance minister into offering sops. The mutual fund industry saw almost Rs 90,000 crore of net outflows in September and October.

“The biggest dent is that there has been a good amount of damage to the investor confidence in fund houses. And that is of utmost importance as it is intangible and extremely critical,” says a fund manager.

The toll that investors have taken due to the fall in markets and redemptions has gathered a lot of importance. Little wonder then that the regulator, Securities & Exchange Board of India (Sebi), has been working on getting more details from fund houses and planning new guidelines for them. Some of the mutual funds, under the guidelines, went too far to compromise on investor interests. This was the case of fixed maturity plans (FMPs) where some of the schemes had invested in simply one company or one sector. Non banking finance companies (NBFCs) were the preferred destination. Clearly, there is a need for greater transparency here and the regulator will soon be addressing it.

Also, the redemption pressure was not an unexpected phenomenon. It had to happen, given the huge liquidity crisis. And the industry need not be blamed for mismanagement. Sebi chairman CB Bhave, while speaking to the media on Thursday, remarked, “We have not yet seen any signs of bad investments by mutual funds. The October phenomenon has given us a good opportunity to take a relook at debt funds and the rules that govern them and to what extent that we need to make improvements in these rules.”

There is, however, a strong case to protect retail investor’s interests. Many who had saved for encashing their savings in October would have been shattered. The importance gets magnified given the fact that mutual funds are now reaching out to rural India and trying to be a part of the ‘financial inclusion’ movement.

There are rumours that the regulator is looking at having separate schemes for corporates and retail investors. Then there are theories that the minimum capital structure for funds will be changed and that there would be emphasis given to close-ended funds or having a lock-in period.

Observers point out that having a separate fund for corporates and retail investors might be a good idea as these were the ones who pulled out of the funds when their own liquidity issues arose. However, this is already being done, albeit in a different manner. Corporates mostly participate in liquid and debt-based funds, while retail participation is extremely low.

There are high net worth individuals, but they too operate under expert advice.

Having a close-ended mechanism coming back technically sounds a great idea, say experts. The fund manager can breathe easy as he does not have to change the fund portfolio make-up each time there is redemption pressure.

A close-ended fund is finite and has a investing time frame, say, six to ten years, and is made available to initial investors through the new fund offer route. When the offer is closed, the fund gets listed on the exchange and investors can move in and out of the fund through the secondary market.

The asset under management does not change on account of redemption, unless there is a special redemption window offered by the management. Such schemes were extremely popular in the nineties.

However, the catch is that the traded price of the scheme is often at a steep discount to the net asset value. So the investor might not be able to exit at a great price.

Moreover, the investor could now be exposed to two market risks – one on the portfolio where the assets purchased change in value with the market, and then also on the traded price of the units which are listed on the market. Hence, this avenue could as well be detrimental, say sceptics.

The point is that investing in mutual funds, like any other investment, will be fraught with risks. There is no wishing it away and this is something that the retail investor has to come to terms with. And this is one area where the regulator will have to look into – investor education.

“My colleague, who is a double graduate, still thinks that mutual funds and shares are the same,” says Prabal Sarma, a Mumbai-based executive. There are a lot many initiatives under way and there is enough groundwork done. However, a lot is still left to be done and this is one of the key learnings from the bloodbath.

Sebi has, interestingly, taken an initiative in this direction that must be lauded.

And that is undertaking a survey to understand the Indian investor’s psyche, their preference for investments in different instruments, like equities, bonds and mutual funds and to know the reasons for not investing in securities market.