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Home >Opinion >Mutual funds in demat accounts pave a smooth road

The exercise of dematerializing physical shares, which mostly happened in the 1990s, revolutionized the equity market. It dramatically reduced market risk and shortened the turnaround time of transfer, which resulted in the explosion of volume. This happened when dematerialization was made compulsory. Now, dematerialization of mutual fund (MF) units, too, needs to be made compulsory for India’s development and future.

One of the positive developments in the past year has been the focus on seamless execution and removal of implementation glitches that often scuttle commendable initiatives, such as the introduction of direct plans, focus on usage of online platforms for MF transactions and ability to hold units in a demat format.

While direct plans and online MF transactions have witnessed significant traction, holdings in demat form continue to have few takers, even though demat accounts offer investors numerous advantages, including reduced paperwork, the ability to hold all financial holdings in a single account, single nomination facility for all financial holdings, and no need to keep track of multiple portfolios. Additionally, there are significant advantages for asset management companies (AMCs) as well, such as more connectivity to the nationwide depository and stock exchange platform (thereby creating a larger potential future distributor audience for their products) and improved investor holding data statistics to avoid the age old problem associated with multiple MF folios.

Further, this will ultimately enable investors to have a single view of their entire portfolio across securities, MFs, insurance (with demat insurance policies now operationalized by the insurance industry), bank fixed deposits, and post office investment products (enabling regulations were approved by the board of the Securities and Exchange Board of India in 2012 and is currently pending implementation).

A closer look at execution for demat MFs, however, reveals the reasons for the lack of traction. Typically, the investor with a demat account tends to be more technically and financially savvy through the use of online platforms and direct plans. Consequently, the investor requires the following three advantages:

1. A high degree of convenience, which online transactions give.

2. Reduced cost, which comes through direct plans, and

3. Higher efficiency, which comes as holdings are consolidated in a single demat account.

The current model, however, results in the investor being able to only hold a maximum of two of the important three advantages. For example, as most AMCs do not offer online subscription and redemption functionality for demat MF holdings, the investor ends up investing using an online platform involving direct plans without the advantage of demat holding. This problem is further accentuated by glitches in investor servicing, such as difficulties in obtaining any portfolio data from AMCs and roll-over of fixed maturity plans.

Given such challenges, how can dematerialization be increased? In the securities market, the path has already been well-established since the late 1990s. Now almost all stock market transactions take place in demat format. Based on that precedent, multiple approaches can be adopted, including:

1) An investment threshold based approach: Mandate new, sizeable MF subscriptions to be compulsorily held in demat format (for instance, new subscriptions above 1 crore).

2) An investor category-based approach: Mandate a certain category of investors to make new MF investments in demat format only (e.g., companies).

3) An MF category-based approach: Mandate a certain type of MFs to be held in demat form only (e.g., liquid funds—these are similar to exchange-traded funds, which are in demat format only).

With increasing dematerialization, AMCs will also be able to suggest further measures to streamline processes, such as working with the regulator to negate the need for an MF-specific know-your-client (KYC) requirements to be undertaken by the investor and instead relying on the single KYC undertaken by the depository, insurance repository or banks.

This will, in turn, promote development of a world class financial advisory business, wherein intermediaries can leverage technology to have a comprehensive view of their client’s financial assets, and focus on value-added services like financial needs analysis and portfolio planning, rather than spending effort on document maintenance and administration.

The demat MF initiative consequently needs to be viewed as a building block of the country’s financial architecture and supporting government policy objectives of making it convenient for investors to hold financial assets rather than physical assets (particularly for small investors or senior citizens for whom the administration of their investments is itself daunting), and not an isolated technology initiative.

It is time to collectively re-examine the implementation of demat holdings by the MF industry and to work towards solutions that will bring the MF industry at par with the rest of the Indian securities market.

Sanjiv Shah is the chief executive officer, Goldman SachsAsset Management (India) Pvt. Ltd. Shailesh Mamnani contributed to the article.

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