Market regulator SEBI has issued a
circular defining categories for mutual fund schemes, and the number of funds
permitted under each category. Consequently, fund companies will be forced to
either merge or liquidate all additional schemes.
For some time now, there have been
rumours that SEBI has been nudging fund companies to reduce the number of
schemes on offer. By issuing a circular, SEBI has forced fund companies to act.
I have no hesitation in saying that several Indian fund companies
have been poor stewards of investors’ monies. They have been
guilty of recklessly launching funds (often with poor investment rationale)
with the sole intent of shoring up assets.
Furthermore, I believe that SEBI acted with the best of
intentions, to aid investors make informed decisions by easing
the selection process.
That said, I’m afraid that SEBI’s
solution is flawed because it lacks nuance, and is
unlikely to result in an improved investment experience for investors.
Is fewer options necessarily
better?
Clearly, the guidelines are aimed at (a)
reducing number of funds and, (b) bringing uniformity among funds in each
category.
So, if the new fund offer (NFO) launch
spree resulted in too many funds (read choices) for investors. SEBI's solution
is on the other end of the spectrum—extinguish a number of funds, thereby sharply reducing choices
available to investors. I'm not convinced that the latter is
necessarily in investors' best interests.
Let's take an example to better
understand why limiting choices need not be a good idea.
With the exception of three categories,
the guidelines state that one fund is permitted per category. Hence each fund
company can have say, one Large Cap fund.
Even a cursory glance at the present
large cap funds reveals that there exist funds of different hues and
colours.
There are funds that take cash calls, and
others which are fully invested at all times; some which adopt a buy-and-hold
stance and others that churn the portfolio rapidly; funds with
benchmark-agnostic and benchmark-aligned portfolios.
Many of these contrasting investment styles
can be found in the same fund company. Each investment style is apt for an investor with a
distinct risk profile.
However, SEBI's guidelines could result
in investors not having access to funds that are apt for them.
In a move that is seemingly at odds with
what the guidelines aim to achieve, categories such as Dividend Yield Fund and
Value/Contra Fund have been permitted. But how does one define what
constitutes a dividend yielding stock, or a value/contra pick for that matter?
One can’t since, there is no universal definition.
In effect, fund companies have been
handed a loophole that they can freely exploit. Such a
scenario can negate SEBI’s intent to ‘standardize characteristics of each
category’.
Status quo for close-ended
funds
In a major gaffe, the guidelines are
applicable only to open-ended funds. The close-ended funds segment,
which is a hotbed of questionable funds with little differentiation, and
rampant mis-selling will continue to thrive.
I won’t be surprised if we see a large
number of close-ended NFOs being launched in the days to come.
Bloated asset sizes of merged
funds
To my mind, not many funds will be
liquidated in light of the ‘one fund per category’ rule. Liquidating funds
means loss of assets, and in turn, loss of revenue for
the fund company.
Instead, we will see a record number of
mergers. In several cases, the merged fund will have a bloated asset size making it
unwieldy. Liquidity management issues could crop up, adversely
affecting the performance.
All in all, the guidelines may have been well-intentioned, but I fear this will end up as a case of throwing out the baby with the bathwater.
