In the last few months, I have often spoken about the need for higher transparency in financial matters. In fact, not only me, but ever since the Satyam scandal broke out, almost everyone has called for companies, funds, banks and everyone else related to the financial sector to be more transparent. When it comes to mutual funds, it has been heartening to see the Securities and Exchange Board of India (SEBI) do its part, especially in the debt fund industry.
In response to the crisis faced by debt funds in October 2008, Sebi had rolled out new rules to the operations of debt funds in December and then again in January as well.
In effect, these new rules ? shutting off early redemption, banning salesmen from stating indicative yields and reining in the maximum maturities of liquid funds ? were aimed at seeking higher transparency in debt funds and I believe that, by and large, they would do what they have been enforced to do.
However, at such a time when our market regulator is all for more transparency, it seems that the mutual fund industry doesn?t want to be so transparent. The issue in question here is the recognition of non-performing debt assets.
As per Sebi?s current rules, if the issuer of a debt security delays payment of interest or repayment of capital by more than a month, then that investment must be marked as non-performing and its value be deducted from the NAV.
This makes that asset?s value fall to zero, hence, not giving the fund investor any different idea from what actually is. This is a strict value and in my opinion, has served investors well for many years.
However, some funds now want this rule to be modified. As of now, debt funds can hide such non-performing assets from investors for just one month. But the funds now want Sebi to extend this period to three or even six months.
Basically, the fund managers have committed blunders by investing in bad assets and they now want to hide these blunders from investors. Doesn?t sound too good for investors, does it? Well, it?s not.
The problem arose when a handful of debt funds built up massively undiversified portfolios with an overwhelming exposure to specific sectors or individual companies. Creating such portfolios seemed commercially advantageous in the short-term, but it was actually against every prudent long-term fund management principle. Such portfolios made these funds ticking time bombs, which have now blown up and made their AMCs run helter-skelter in a bid to hide them.
Transparency is one of the biggest reasons why investors invest in mutual funds. On a whole, mutual funds have not seen any scam like the ones that have plagued other financial areas in India. Equity funds are very transparent about their activities.
Debt funds haven?t always been like that, but Sebi is now trying to ensure that they are. The debt fund industry has become a sort of quasi-banking activity wherein salesmen openly imply that investors? money is safer with them because their AMC is owned by a bank or a large conglomerate.
Funds? marketing outfits were even encouraged to imply guaranteed returns. While, Sebi has officially put a stop to that, how it reacts to the readjustment of the hiding period of non-performing assets remains to be seen.
If the period is readjusted, it will put a big hole in Sebi?s attempts to increase transparency and might make debt fund management fraudulent. On the whole, it won?t make things any better for anyone involved.
The author is CEO, Value Research