It is evident from some media reports that Sebi is set to increase the minimum capital required to set up an asset management company. Currently, the capital requirement for getting into the mutual fund business is Rs 10 crore.
The trigger for this move seems to be the liquidity crisis faced by some mutual funds in October 2008. At the time, many AMCs found themselves unable to pay up the ‘indicative’ yields they had promised to investors. One big reason was that debt funds that had illiquid underlying portfolios and should have been closed-end funds were actually being run as open-end funds. Another reason is that the rules for valuing illiquid debt securities were far too liberal. These root causes of the crises were inadequate regulations, which have now been fixed.
During the crisis, some AMCs, which had deep pockets (or which had parent companies, which had deep pockets), used the cash available to them to tide over the crisis. Since that time, I find that executives of the some bigger AMCs have started talking about how the business should have a higher capital requirement, presumably to shut out. However, this idea is completely misguided. It is based on a mistaken notion of the asset management business.
Mutual funds should be in the business of investment management, which means that they should just act as an agent who chooses the right investments and implements the mechanics of buying and selling investments and keeping accounts for investors. During the liquidity crisis, mutual funds got into the business of pretending that a liquid market existed for debt securities. In reality, no such market existed. If funds are to be permitted to create this make-believe liquidity, only then do they need lots of capital.
If a fund has invested in illiquid securities and failed to anticipate market problems, then its investors should suffer for it and so should the funds’ reputation. That’s the way competition should work. Moreover, a higher capital requirement will actually stifle competition in the mutual fund business and create an entry barrier that will work in favour of large entrenched players. As long as a strong transparency framework is in place, there is no particular problem with small AMCs. In fact, we have a built-in bias for larger outfits. It is often assumed-by individuals and by the regulations-that larger companies will be better run and that is important for the regulations to mandate a minimum size in many businesses. The events of the last one year should disabuse us of this notion. From the ex-titans of Wall Street to Satyam Computers, there are plenty of large outfits that have abused our trust.
Actually, if the auditing, regulatory and transparency systems are working well, then it will probably be better to go with smaller businesses.
In asset management, investors will probably be better served by lowering the capital requirement. A larger number of niche players will be better than a small number of larger AMCs.
The author is CEO, Value Research
