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
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