Thursday, June 21, 2012

SEBI Throws a Bombshell on Mutual Fund Asset Management Companies

As you may all be aware, the Indian stock market regulator SEBI comes up with rules and regulations with respect to the stock market investments in India. As recent as April 2012, I wrote an article titled “SEBI’s New Rules on Managing Schemes and Disclosing Returns for Mutual Funds” wherein SEBI had instructed all AMC’s (Asset Management Companies) to appoint separate fund managers for their different schemes and set a benchmark for measuring their performance.

Today the chairman of SEBI Mr. Sinha dropped another bombshell on Mutual Fund Asset Management Companies that manage equity oriented schemes. The purpose of this article is to analyze this high-profile and high-impact news.

What is that bombshell?

Mr. Sinha has said that SEBI is going to probe Mutual funds for non-performance of schemes as well as for non-compliance against stated investment objectives.

Why did SEBI come up with such an announcement?

The answer is simple. “To Protect Investor Interest”

SEBI Wants Mutual Fund Schemes to do the following:
a. Perform consistently
b. Meet the investment objectives as stated in the offer document

Performing Consistently:

The term “Perform Consistently” is very broad and cannot be explained in one or two pages. In short, SEBI wants fund managers to at least meet or beat their benchmark index performance. SEBI feels that, if a fund manager is unable to meet or beat the benchmark index performance for 3 consecutive years, then the fund house is being unfair to its investors. SEBI feels that people invest in Mutual Funds to achieve better returns than what they can do so because the funds are being managed by professional experts. So, if these experts can’t even meet the benchmark index performance, then the fund manager and the AMC must own responsibility and start answering to the investor population.

Mutual Fund performance is always measured by comparing its performance against the benchmark index to which it is tagged. If a fund is tagged to the BSE Sensex, as a common investor, the returns of this fund should be at least better than what the BSE Sensex generates. If the fund is unable to do so, it is considered an underperforming fund.

Mr. Sinha said that 9 AMC’s (He did not take any names) have more than 50% of their schemes consistently underperforming their benchmarks for 3 years in a row. SEBI will be questioning both the fund managers as well as the sponsors of the AMC for justifications as to why they have been unable to perform at par with their peers.

Meeting Investment Objectives:

Every mutual fund scheme has an investment objective that is clearly stated in the offer document. It goes like “To generate capital appreciation by investing in high-growth stocks while safeguarding investments with a healthy exposure to debt instruments”. Forgive me if this objective doesn’t sound like a real one, but to give you an insight, the investment objective just tells the investor what the fund is planning on doing in the years to come. Simply put, if the fund manager says “To preserve capital while trying to generate good returns” and the funds NAV has steadily fallen over the past 3 years, then there is something fundamentally wrong with both the fund house and the fund manager. It is this kind of scenario that SEBI wants to address. If a fund scheme suggests or claims that it will do something, then it must. If it doesn’t, then it is almost similar to the bait-and-switch con schemes that are illegal in almost every country in the world. If a fund manager is unable to meet the investment objectives or generate good returns for the investors, it is the responsibility of the fund house (AMC) to address the situation and if required replace the fund manager. Since there are numerous cases where both parties have failed to do their job correctly, SEBI is forced to intervene.

What does this mean to the AMC’s?

AMC’s can no longer hide behind the clout of “Bear Market Scenarios” for poor performance. SEBI does not say that Mutual Fund schemes cannot make losses. All it is saying is, if the benchmark index is going up or down by 10% then you try to at least match that 10%, be it profit or loss. Don’t underperform when compared to the broader index. I would say that this is a bare minimum requirement that you would expect from a seasoned and experienced fund manager. At the end of the day, if the fund manager can’t make wise investment decisions, what is the point in us investing in those schemes?

AMC’s will be forced to own up to their mistakes. What SEBI plans on doing with those under-performing AMC’s and their fund schemes is still under speculation. If you ask me, I would say:

“SEBI should give a deadline by which the AMC and the Fund Manager must clean up their act, else they must be forced to shut down the scheme to protect investor interest. Also, in such situations the AMC must be penalized for letting down the investor and approvals for flouting new schemes must be denied to that AMC in future.

Another important impact on the AMCs is the fact that, they can no longer do whatever they want with their schemes. If the scheme says it will do X, Y & Z then it must do it.

Verdict: This is very good news for the investor population of India.

Now that SEBI has started a probe on schemes that are not compliant to their stated objectives, I am hoping that fund houses will quickly clean-up their act and ensure that their funds do what they started out to do and at the same time ensure that the funds are performing at par with the index to avoid penalties and negative publicity.

Happy Investing!!!

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