‘Mutual fund (MF) investments are subject to market risk. Please read the offer document carefully before investing.’
This is the mandatory disclaimer that all MF houses have to show at the end of every advertisement. Moreover, the Securities and Exchange Board of India (SEBI) has mandated that the disclaimer should be shown for a full five seconds.
And that’s not all. Every penny that a fund house spends on advertising, marketing and distribution and also the manner in which it spends is highly regulated.
In October 2017, SEBI also laid down guidelines for categorisation of MF schemes.
So, what more can be done so that MFs do not end up in a situation that is being talked about in the markets?
Some fund houses, through their debt schemes, had structured exposure with promoters of certain firms, which effectively was a lending activity in the form of loan against shares.
Such exposure is now being questioned as the underlying shares of many conglomerates like Zee Group, Anil Dhirubhai Ambani Group and Dewan Housing Finance, among others, saw significant and swift erosion in their share prices.
“Investment against shares is more of a lending activity than investment activity and hence regulations should be different,” said J.N. Gupta, MD, Stakeholders Empowerment Services (SES), a proxy advisory firm.
“However, if there are many rules to comply with, then only the compliance cost will increase. A proper disclosure regime is better than extreme regulation,” added Mr. Gupta who earlier served as an ED with SEBI.
Incidentally, there are many who believe that MFs should be barred altogether from such activities due to the significant risk involved.
But look at the returns of a plain vanilla mid-cap or even a large-cap equity fund and chances are that the one-year return — even longer tenure in many cases — could be in the red. So, should one ban such funds as well?
Higher risk
There is no denying that the risk is higher in such debt products but if a riskier product is offered with the right disclosures then an investor can take a better informed decision. And that is what the regulator should do if it thinks that there is further scope to tighten the disclosure norms for MFs.
It’s a very fine line. There are many who believe that the ongoing developments do not pose a systemic risk like the one seen post the IL&FS crisis, which led to SEBI introducing the side pocket framework.
“Nothing needs to be done by SEBI as whatever needs to be done has already been done,” said Dhirendra Kumar of Value Research, a MF tracking company.
“Side pocketing was a very important decision by SEBI to safeguard investors against investments turning bad,” added Mr. Kumar.
Debt funds have been in existence for decades and currently have assets totalling ₹15 trillion. Till date, only a negligible part of that has turned bad.
It’s also a fact that every investor has a different level of risk appetite. Incidentally, there is a global market for even junk bonds and smart money managers have made money on such instruments.
SEBI can also look at the business model for rating agencies as, based on the actions of such entities, fund houses decide on the quantum and even price of debt products. Mr. Kumar is of the view that a change should ideally lead to a change in rating.
The reality is that equity investments — whether direct or through MFs — would always have an inherent element of risk. Then, remember the disclaimer.