Point

Major changes in the regulatory framework for the Mutual Fund (MF) industry in the last more than a year have been undertaken with the primary purpose of increasing ‘Transparency’:

• Scrapping of entry load to increase transparency in payment of upfront commissions to distributors;
• Cap on expense ratio for ensuring transparency in Net Asset Value (NAV) calculation and expense calculation;
• Valuation norms for money market and debt securities to align the value of the securities with current market scenario and thereby bring transparency in NAV calculation;
• Increased disclosure requirements for MFs including disclosure of investor complaints in Annual Reports; and
• Maintenance of investor documentation and Know Your Customer details with asset management companies (AMCs) or their Registrar & Transfer Agents.

Transparency is a prerequisite for the development of any investment management service, especially when it involves retail investors with small savings, inadequate social security and lack of financial awareness. The fall in retail participation in last one year may indicate that the pace of regulatory changes may have been too quick, disallowing industry players enough time to adjust. However, if we look from long term perspective, then these changes are prerequisite for the healthy growth of retail participation in the mutual fund industry. The choice was whether to grow retail participation quickly without prerequisite standards or implement prerequisites first and then slowly grow retail participation. Quite obviously, the regulators rightly chose the latter being best for investors.
 
These regulatory changes have forced industry players to make structural changes in terms of distribution network and communication strategy, which may have increased the overall cost of operation for fund houses in the short term. But if we consider long term impact, larger retail participation as a result of more transparency and investor confidence would definitely help in reducing cost and achieve economies of scale, thereby negating any short term rise in cost.

The real test will be the ability of fund houses to generate comparatively better yields and communicate it properly to the masses so as to attract their participation. This is not to undermine the importance of use of better technology and investor education & awareness programmes to improve reach of mutual funds in smaller towns. Infact, these regulatory changes have necessitated fund houses to focus on attracting investors through pull strategy by offering simple products, higher yields, and increasing financial literacy. Only those fund houses which will be able to attract masses will survive in the long term. This reminds me of Charles Darwin’s famous phrase ‘survival of the fittest’.

Counterpoint

The fast pace of regulatory changes has only unsettled the industry, argues Suresh Sadagopan of Ladder7 Financial Advisories.

Voyeurism is interesting. CNN set up a 24/7 channel during Gulf war with direct feeds from the war front.  Many people across the world found it interesting - except the people in the affected countries and near the war front. CNN did good business and established itself as a 24X7 news channel. It’s well timed voyeuristic images beamed live to people conveniently snuggling at home with their popcorn, was actually live entertainment.

It is sadistic - but that’s how we are. Similar drama is being played out in the mutual fund industry. People commenting on MF industry and investor’s interest and making all the right noises are all in secure jobs, earning fat salaries. For them and the media it all a tamasha… and that’s interesting - for them. The magnitude of changes that have taken place in the MF industry is nothing short of phenomenal. And only this industry has been singled out. The timeframe in which it has taken place is just a blip. That is what makes the whole thing sting.

There has been a maelstrom in the MF industry, unleashed by SEBI, in the name of investor interest and protection.  Investor interest needs to be protected. But an industry need not be dismantled to protect investors.

Mutual fund industry is the best bet for normal retail investors to participate in the equity and debt markets.  The normal investor gets professional oversight and management for a small fee.

A few years back, things were sought to be changed by giving investors an option of making “direct” investment for which there would be no entry load along with the traditional route through distributors where they needed to pay the entry load.  The ostensible benefit to the investor is saving of entry load, if they go direct. But 93% of all investments were still done through distributors. SEBI then abolished the entry load completely.

Moreover, there has been a steady stream of niggling regulations that keep the industry perpetually in a state of suspended animation and off-balance.  There have been changes too numerous to mention - from not disclosing portfolios & even indicative returns in case of FMPs, withholding of distribution fees on grounds of documentation, NOC & then No NOC and no commissions for changed folios, no third party cheques, the onerous documentation on bank change (which involves old bank details and documents and new bank details and documents) which many investors find difficult to comply.

Abolishing the entry load is not really the issue. The problem is of a regulator that does not allow the industry to settle down and move on.  Fund houses and their distribution partners need breathing space to make adjustments and create a new architecture, in the changed environment.

Make no mistake about this - the fund houses and their intermediaries will find a way in the new environment, given some space and time. What the industry needs is a regulator who works in a manner that every participant benefits.  Investor interest is not being served now, when distributors have abandoned the industry and the AUMs have been steadily coming down.