When mutual fund CEOs get over-smart
Rahul Dravid filed a police complaint recently accusing an investment firm of cheating him. He invested Rs20 crore in a firm promising a 40% return. He recovered Rs16 crore but is yet to get back the remaining Rs4 crore. Instead of trusting a sharp shooter for higher returns, had Rahul Dravid invested his Rs20 crore in mutual funds, what would his portfolio look like today? The average large-cap 3-year return is 7.31% and the average 5-year return is 14.47%. His Rs20 crore invested 3 years ago would today be worth Rs25 crore and had he invested 5 years ago, he would be sitting on a corpus of Rs39 crore. That is if he got just average returns and not top quartile returns. But he is looking to just recover his principal from the sharp shooter who promised him super returns. Dravid would have been better off in funds than with a ponzi scheme that he trusted in search of more.
Mutual funds have done well and have been in the news for mostly good reasons in the past few years. The number of retail investors is growing, the systematic investment plan (SIP) book is now at Rs6,500 crore a month and long-term investors have seen stability in their money growth. When seen in the context of large banking scams or the loot of investor money due to misselling of life insurance products, or the periodic ponzi schemes that loot not just the rich and the famous, the fund industry looks good.
But comparing itself to thieves and cheats is probably not the right direction to go. Mutual funds have a fiduciary duty to look after investor money and that duty is enforced by a regulator that puts in place the rules of the game so that investors are not defrauded. When fund houses led by sharp CEOs walk on the edge of the regulatory line, sometimes crossing it, they are playing with the trust placed by investors in the industry they belong to. A recent story by my colleague Kayezad E. Adajania has shown how some fund houses are misusing an emergency provision to manage expense ratios. You can read the story here.
The Securities and Exchange Board of India (Sebi) allows mutual funds to borrow money in an emergency situation when faced with a sudden redemption by investors in liquid funds. But some fund houses find it cheaper to borrow money than sell bonds, when faced with redemptions, on a regular basis. They do this to ‘manage’ their expense ratios, or the cost to the investor. Yes, you do get a lower cost but it is coming at the cost of misinterpreting the regulation. That leads to the question—if they can misinterpret this regulation, what else will they be doing that we don’t know about? It reduces the faith in the system and the product.
Further, there are some fund houses that are resisting streamlining their mutual fund schemes. Sebi has asked mutual funds to clean up the clutter in the industry by identifying 36 categories of funds and allowing mutual funds to have one scheme per category. You can read about this here. It has also asked mutual funds to change the misleading names of some of the schemes. For instance, what does the word ‘prudence’ mean to an investor? Or when a scheme is named ‘credit opportunities’ does the investor understand that this means higher risk? Fund houses were given time to change names, merge schemes and comply with the regulation. While some fund houses have already done so—you can read the list here—most of the big fund houses are conspicuous by their absence in this list. Sebi insiders say that there is a lot of resistance from some of these fund houses. But given that these regulations are applicable only to open-ended funds, some fund houses are launching a series of closed-end funds. This is being done in the name of the investor, but is aimed at gathering assets under management to retain their place in the pecking order in the industry.
Another instance of sharp practices in the industry comes from a recent story that reports that mutual fund expense ratios will go down since the regulator may reduce what funds can charge the scheme, from 20 basis points (bps) to 5 bps. One basis point is one-hundredth of a percentage point. In 2012, Sebi allowed mutual funds to charge an additional 20 bps to compensate them for ploughing back exit loads into the scheme. Funds were charging a higher amount to the scheme while their actual costs were lower, says the story. But speak to industry insiders and you find out that plenty of funds that were not even eligible to charge these exit loads were charging them.
Closed-end funds typically don’t have exit loads since they are not open to redemption in the middle of the investment period. For closed-end funds to charge this cost to investors is not walking on the edge of regulation but violating it. Sebi needs to claw back these costs and refund investors who have been cheated.
When seen in the context of what happened to Dravid, these violations may look small, but they corrode the trust that has been hard fought for. It has been a long journey for the mutual funds industry to generate interest and acceptance in the investor’s portfolio. Some CEOs of fund houses are putting that trust at risk by playing the game fast and loose.
Monika Halan writes on household finance, policy and regulation. She is consulting editor Mint. She can be reached at email@example.com.