One size does not fit all

Mutual funds should be categorized as per their risk profile and allowed to impose flexible or flat fees

If 2018 was the year of reform, 2019 might well be the year of reckoning for mutual funds. After management and administrative charges were revised down and capped last year, increasing scrutiny of their investment style is likely to be the theme in the current year. Shares of listed asset management companies lost value after the Securities and Exchange Board of India in September sharply curtailed fees by introducing an inverse graded structure. The step does not seem to have translated into a rush to get in. Instead, more investors are exiting than entering mutual funds since the beginning of the current calendar year. After recording an increase in November and December, net purchases of all units slid 35% in January from a year ago. Net redemption in February were double of net sales 12 months ago. Net inflows into debt and equity have been nearly flat in the 11 months to February. Those into equity schemes are on a decline: down 63% in January and 73% the next month. Income schemes have seen net outflows for all the months of FY 2019, except April and December 2018. The pace of investment through the systematic investment, the mainstay of mutual funds, slowed down to a two-year low in February. Only 21% more subscribers opted for the route compared with the 52% higher number seen six months ago. The question is if the disappointment of investors is a blip due to the anticipated turbulence in the run-up to the general elections in April and May or a beginning of the end of the infatuation with mutual funds as being safe vehicles providing decent capital appreciation over a long period. 

Just as the collapse of IL&FS triggered risk aversion and drying up of credit to the financial services providers, any disruption in the supply of cash to mutual funds will affect issuers of equity and debt in the primary market. Mature frontline stocks will gain at the expense of risky mid and small caps in need of capital to grow and rapidly multiply the wealth of their shareholders. Fixed income instruments will have to offer higher coupons as bulk buyers become selective and demanding. To provide comfort to investors, Sebi has allowed side-pocketing of assets under stress to protect the remaining portfolio. Some mutual funds have agreed to give promoters time to raise money to get their mortgaged shares released. These solutions have not addressed core concerns. In the race for out-performance, due diligence seems to be the casualty. Small investors are consistently told not to get distracted by intermittent fluctuations. Yet fund managers do not follow their own advice of staying invested even during turmoil. Portfolios are shuffled frequently out of greed and fear. Pledged shares are dumped on signs of company-specific headwinds. The grace period given to borrowers stems the downside but imparts uncertainty to the stock’s direction. Whether investors who stay put rather than exit the scheme containing the affected company benefit or lose depends if the divestment of non-core holdings turns the flagship business attractive or a shadow of its former glory. The cash that becomes available due to prepayment of the loan brings with it the problem of deployment to generate earnings.

The total expense ratio has been capped at 2.25% for open-ended equity-oriented schemes. It slides to a low as 1.05% if assets are more than Rs 50000 crore. The unintended consequence will be an aggressive drive for subscriptions to boost the absolute value of the fee income even if the mandate confines exposure to a limited number of stocks. Overheads can remain low if fund managers ignore lucrative opportunities by staying with their picks. Inflows accelerate in a rising market when stocks are expensive and decline over a bearish phase when quality counters are available at a discount to their highs. If optimal utilization of the corpus during a bull-run can beat the benchmarks, it also makes the investment vulnerable to volatility as old ideas make way for new themes. In the course of a downturn, the mood is cautious. The preference is to remain liquid despite being in a buyer’s market. The push of AMCs for SIP and long-term investing is to even out these bumps. The regulatory thrust on making mutual funds accessible and economical should not mask the fact that rewards are dependent on bold bets long on potential but short on track record. Schemes need to be categorized as per their strategy spelled out in the offer document. Fees chained to returns rather that to the size will act as incentive to perform. SIPs should be for passive instruments such as ETFs with a flat entrance charge to suit the needs of those investors who want a steady income at low cost.    

-Mohan Sule

Clear and present danger

Whistleblowers, companies suddenly changing their business profile and regulatory challenges are risks facing investors

The dangers to the well being of companies are no longer restricted to economic headwinds and familiar governance missteps. As disclosures become more rigorous and access to information improves, the traditional tools of cover-ups and divergences are being pushed aside by newer threats. Unlike clashes of opposing opinions on issues such as use of idle cash, diversification into unrelated areas and share-swap ratios, that can at worst bruise investors, recent eruptions have left behind a trail of havoc. Of the three contributors that have damaged stocks of late, whistleblowers have caused the most destruction. Revelations of links of the promoters of the Essel group to firms being probed for money laundering post demonetization, loans by promoters of DHFL to shell companies and handling of the distribution business of Sun Pharmaceuticals by the co-founder have created doubts about the credibility of those at the helm of these companies. Sun has now replaced the related party with a subsidiary and dismissed accusations such as ties with manipulators and handling of overseas capital-raising exercise by a related entity as old events. The Essel group and DHFL have denied the allegations. Sebi was in the midst of examining and seeking explanation from Sun when the complaint was released into the public domain. The result was asymmetrical dissemination of the compilation of misdeeds, going against the basic principle of maintaining the sanctity of the market. Some institutional investors resorted to panic selling. To plug motivated leakages, without giving the company a chance to defend, the watchdog has to ensure that those who benefit from such selective disgorging of information are made to compensate the small investors to the extent of loss caused by their trades. A whistleblower in 2016 had charged not only the MD and CEO but many board members of Infosys of knowingly undertaking a costly purchase of two Israeli firms. Eventually, the regulator mid 2017 issued a clean chit in the absence of supporting evidence. Undeterred, a whistleblower has approached the SEC to point to delay in filing some forms by the tech solutions provider. Whether the recurring snapping at the management is to harass or trigger a clean-up is not clear.

If vanishing companies dominated headlines at the turn of the century, vanishing businesses are likely to be the talking point at the turn of the current decade. Earlier, promoters latched on to a fad, came into the market with pricey issues, got the shares listed and forgot about them. The stock exchanges did their duty by delisting them for not keeping up with the disclosure requirements.  Though those behind these ventures are banned from entering the capital market, the shareholders have been left holding worthless paper. The new-age entrepreneur is smarter. He prefers to eject the core business and embarks on another adventure, without a thought to the investors who had bought into the original idea. Prabhat Dairy has got out of the milk-processing business that contributed 98% of the revenues, turning to cattle feed instead. How much of the Rs 1700 crore that the transaction has garnered will trickle down to the non-promoter shareholders is not known. The organization has been structured in a way that the cash-generating operation was run by unlisted subsidiaries. The turn of events has brought to the surface the risk of investing in companies with marginal retail presence and a web of holdings that ring-fence the beneficiaries.

Healthy companies thrown into turmoil by owners leveraging their holdings for personal gains is one side of the coin. The other is made up of promoters who create an overhang of uncertainty over their stock. Uday Kotak was supposed to reduce his 30% stake in the private bank he set up in phases, by 10% end December 2018 and 5% end March 2020, when it completes 15 years.  The current controversy hinges on how the Reserve Bank of India’s guidelines on control should be interpreted. The matter is now in court after the central bank turned down the issue of perpetual non-convertible preference shares that would have increased Kotak Mahindra Bank’s paid-up capital and brought down the founder’s holding to just below 20% without diluting the voting prowess. In the process, Kotak seems to have followed the letter but not the spirit of the law that aims to discourage concentration of power. The Kapoor and Kapur families, who established Yes Bank a year later, have already cut their presence to around 20% of the equity capital. Why institutional investors have not stepped in to compel a closure is a mystery.

-Mohan Sule