Over the last few years SEBI has come up with many rules and regulations for making the lives of the investors simpler. The regulator is clearly batting for the end investor and is hoping to make the lives of the investor that much simpler - making it that much easier to invest in mutual funds. AMFI is doing its bit too – with the high decibel and highly engaging ‘Mutual Funds Sahi Hai’ and now the ‘Jan Nivesh’ initiative to make mutual funds known to the retail investors that much better.
The heart is in the right place no doubt with the SEBI Chairman touching upon the “concentration issue” and stating that the top seven AMCs account for 70% of the AUM. Not only in terms of AUM but the SEBI Chairman also referred to revenue and profit share as benchmarks for concentration.
Right now there are 42 players in the mutual fund space, what if there could be 420 or 4,200? The biggest impediment to the establishment of an AMC is the Rs.50 crore net worth imposed by SEBI. What if that was brought down to Rs.5 crores or even Rs.1 crore! Here’s how we think this could help:
Increasing the number of AMCs
We believe that there are hundreds if not thousands of distributors, IFAs and CFPs out there who are managing the money of their clients in the right way. They are not in it just for the sake of making money but are genuinely interested in creating wealth for their clients and investors. Such distributors and IFAs have built a track record of managing investor money over a long period of time. Getting them to start a fund house of their own may be a step in the right direction. We see examples of large broking houses that have their own mutual fund small business units (SBUs). Those companies are managing the inherent conflict of interest well.
There are listed distributors out there too, who fulfil all the regulatory requirements as they are listed entities, complying with the statutes of the Indian stock markets. Therefore, many distributors can fulfill the requirements of a sponsor and should also be given the opportunity to prove themselves capable of managing money and cater to their client base as a fund house and would increase the number of AMCs, which is what SEBI wants.
We believe that the tier 2 and 3 cities will be the greatest beneficiaries as there will be a slew of local distributors who may be tempted to set up their own research teams and start an AMC to launch simpler products. This will give more of a choice to the end investor as to whether he would want to invest in a ‘local’ AMC or a ‘national’ one.
Emergence of technology
The use of technology can also help level the playing field and increase retail participation. As internet penetration and the penetration of handheld devices like smart phones and tablets increases, (as per an IAMAI report in December 2017, approximately 481 million Indians now have access to the internet, the number would have crossed the 500 million mark by now – this is more than the population of the US!) more people can then start transacting online to purchase/redeem their funds. Toll free numbers make the fund house fully accessible in case of any queries or issues. Innovation in this area, like creating a completely online KYC, investing experience without any paperwork (an initiative for which Quantum has been a pioneer), will go a long way towards increasing penetration.
The regulator can also help us here by streamlining the process of KYC. For every financial product an investor having a bank account shouldn’t have to do a different KYC one centralized KYC for everything –purchasing insurance or mutual funds should be put in place as soon as possible.
Thus in the current age of technology and with specialized service providers available, the need of capital for minimum infrastructure requirements is also reduced.
Innovation is the key
Smaller players do not have the resources or the means of the larger players and therefore have only one way open to them – innovation. Smaller players tend to come up with innovative ways to tap into investors or come up with innovative products that can add more investors to their fund. The best example one can give is that of Vanguard, which started off as a direct to investor fund and was a small player initially. Vanguard is now the largest fund house in the US managing more than $5 trillion. Thus, we believe that this move of killing the small players will also kill the innovation that small players bring to the industry, thereby helping the entire industry to grow.
Pitfalls of the high net worth rule
- Higher networth need not necessarily mean higher accountability
- Focus of shareholders/sponsors will be RoI, hence, chasing more AUM than servicing
investors in the right way - This will increase the probability of fresh malpractices creeping up and a high net worth will
probably ensure that the AMC pays the fine imposed without batting an eyelid. - Also, when a security defaults or the AMC takes over a security that has defaulted on its own
books and infuses cash in the fund in return to make good the loss, the net worth of the AMC goes down, as per the accounting rules. The regulations should be such that in these cases, the AMC should be forced to increase the net worth.
Global regulatory framework
- The FSB (Financial Stability Board) has also recommended a minimum capital requirement for banks and other financial institutions to prevent another collapse like the 2008 crises. Reducing Systemic risk is on top of the FSB agenda. FSB also sees systemic risks in the asset management business due to large money market funds across all geographies that are not valued on a mark to market (MTM) basis and projected as a constant value fund.
- Capital adequacy for the asset management business essentially flows from this, which is not correct yardstick and applying some of Basel recommendations on operations risk, seems to be the basis of proposing capital requirement for AMCs.
- Being a pass through business, there is no counter-party risks in AMC business unlike in banking, yet portfolio construct could give rise to credit/market risks which can be detrimental to the interest of small investors and cannot always be passed on to the investors. This scenario arises when the portfolio valuation is not at fairvalue incorporating the MTM. A high net worth or a rise in net worth will not protect the funds in bad times, as seen in October 2008 and July 2013.
What should the regulator do?
For the number of AMCs to grow the regulator needs to remove the gargantuan financial requirement to set up an AMC. Having a mammoth minimum Rs.50 crore net worth rule will ensure that only companies of a particular size can set up an AMC. While doing a Japan (of having zero entry fees to set up an AMC business) may not be possible, maybe having different bands of net worth fees can be looked at.
A viable solution can be to have stringent norms on penalizing underperformance, mis-selling, malpractices and encouraging transparency and improving service standards to investors. The size of the assets of a fund house or its net worth shouldn’t matter, what should matter more in this present day situation is - investor protection, investor education and risk management systems in fund house to give the investor the best experience and optimal returns. A perception has been created that small fund houses cannot manage the funds well and may face redemption pressures largely in liquid funds. Liquid funds have always been projected as a constant face value Fund thus resulting in mismatch in expectations of returns by customers vis-a-vis the reality of MTM risk in the portfolio of a liquid fund since the portfolio is valued at mark to model instead of mark to market (MTM).
Conclusion
Thus in our humble opinion, we re-iterate that just like SEBI waived off entry loads for the end investor for mutual funds, SEBI should also lower the net worth barrier. This will allow many more fund houses to flourish and also widen the net of mutual fund subscribers especially in the Tier 2 and 3 locations.
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