Why SEBI should look at a participative and all-inclusive growth model for MF industry

The industry is well supportive of introducing regulations and initiatives to improve the transparency and accountability of the fund management process which is in the best interest of the investors. While the industry welcomes that the recent TER recommendations are also along the similar lines, however there could be unintended consequences like mis-selling, limiting the reach to masses, limiting the churn in portfolio to save brokerage, restricting liquidity and market making in a larger context. While the thoughts behind the suggested measures proposed are profound, they are constrictive for mutual fund industry’s ease of operations. There is already a talent drain in mutual funds where fund manager veterans are setting up their own PMS shop or joining the less restrictive Buy-side segments like Insurance industry, family office etc. With measures like these, the talent erosion in mutual fund industry is only going to continue if not worsen. SEBI should also consider that investor welfare does not only circle around only the TER. An informed investor should also be looking at the fund manager credentials, fund house credibility, performance track record apart from the expense that she is going to bear. While SEBI’s rationale in providing transparency in the operations of mutual funds is appreciable and suggestions to incorporate wider option of charges to be included with TER which in the long-term benefits investors will help. Nevertheless, for the same investor, it is imperative that the savings from brokerage and research do not end as costly losses or more than compensated from transaction costs (from illiquidity), inadequacy of research (as having several broking houses brings about wider views). Again, the same investor should not be constrained of choices and active fund management, if mutual funds gradually move to passive strategy. SEBI should find a middle ground here, where both broking services and mutual funds can co-exist. Mutual funds cannot substitute the liquidity and market making services provided by brokers. SEBI Proposal - I: To ensure the accrual of benefits from economies of scale is passed on to investors and encourage participation of newer AMCs, SEBI has proposed slab-wise TER basis AMC level AUM as against the Scheme level AUM This consultation paper favours the small AMCs. However, there can be a flip side to capping TER basis the AMC level AUM. By putting a cap on the AMC level TER, there can be some unintended outcomes, such as continued mis-selling because of higher distribution pay-outs from smaller AMCs. Besides unintended consequences like mis-selling, it may defeat the overarching objective of increase in financial penetration and reach to the masses. Objective of mutual funds is to achieve scale through larger penetration and retail participation. This comes on the back of distribution support and deploying adequate manpower beyond Tier-1 cities to increase retail demand for financial products beyond Fixed deposits and provide investor support. All these are costs to the AMCs which cannot be kept under a stringent cap like the one SEBI has proposed. If we were to achieve our goal of mass penetration of Mutual funds, some rationalization of the measures SEBI has proposed is required. Also, a cap in TER could therefore encourage AMC s to move towards passive funds and have a dampening effect on the growth/existence of active fund management. Given that the financial literacy of the country is still at a nascent level, active fund management is more the need of the hour. SEBI Proposal II: Sebi has also proposed inclusion of Brokerage costs in overall TER (A) and allowing mutual funds to trade on their own behalf by providing membership with Stock exchange (B). This is a Rube Goldberg Machine. Here’s why: A – Relative product disadvantage in construct: Inclusion of broking costs is an untested measure anywhere in the world. This can potentially put domestic mutual fund and its investors at a disadvantage compared to others financial products and its investors who are not exposed to these regulations (AIF, PMS). B – Inhibit portfolio churn: Bringing brokerage and transaction costs within TER limits may discourage fund managers from churning of portfolios, which may otherwise be in the interest of investors. Different fund managers have different styles, some churn a lot and generate high returns for investors, this step will impact their styles and in turn returns for investors as it is almost impossible for a fund manager to change his/her investing style. C – Research is independent of trading services: SEBI thinks that availing brokerage services for ‘research’ is equivalent to charging investors twice for the same cost as investment management fees also covers that. Here’s where SEBI’s thought process is flawed – Industry analysis shows that the investment management fees approximate 50 per cent of the average TER whereas the brokerage cost (excl. STT) is hardly 2 per cent-3% of the overall TER. The charges that a broker levies are hardly anything as compared to the value of services it provides. D – Mutual funds cannot substitute the liquidity and market making services provided by brokers: Apart from providing in-depth research across market breadth, an institutional broker also generates market liquidity and facilitates the large ticket/trade that a mutual fund house commands. With GDP moving towards $ 5Tr there will be many businesses which will need Capital access via Equity, hence investment universe of companies will also increase. To help capture these opportunities, brokers will play an important role with coverage universe and liquidity. E – Favoring large brokers’ is contrary to the fundamental principal of growth, diversification and reach: SEBI’s argument mentioned in the Consultation paper that Mutual funds should favor and avail services of large brokers to keep overall TER and brokerage cost low, is contrary to its desire of favoring the small players achieve profitability as witnessed in its proposal of TER slabs favoring small AMCs. We would want to understand why SEBI has adopted a different approach here for brokers, without adequate ground. F – Expecting mutual funds to take trading membership destroys the principal of an anonymous trading platform: This could be detrimental to the Mutual funds interest. While placing a large redemption order on the trading screen of the Mutual fund, the party at the opposite end could be able to second guess which Mutual fund is placing the order depending on the quantum/lot size and the underlying holding. The interested seller could then take ill advantage of the liquidity requirement of the seller Mutual fund. Allowing trading membership also in fact defeats the entire purpose of the mutual fund only focusing on their Research and keeping their expenses low. It would become increasingly difficult for MFs to play a role of market maker as their core focus remains fund management. In the larger interest of financial inclusion, encouraging savings and providing a stable investment avenue for investors, SEBI should look at a participative and all-inclusive growth model. In the end, the investor should be the winner! The author is Managing Director and Group COO, Equirus. Views expressed are personal. Read all the Latest News , Trending News , Cricket News , Bollywood News , India News and Entertainment News here. Follow us on Facebook, Twitter and Instagram.