Should SEBI be so concerned about size?

Admittedly, “does size matter?” is one of the more tricky questions to answer. Depending on where and when that question is posed, it could evoke different responses from the same individual.

However (and on a more serious note), market regulator SEBI seems to have an unambiguous view on the subject. It is seemingly convinced that bigger is indeed better. Not too long ago, it mandated that the minimum net worth of asset management companies (AMCs) be increased to Rs 500 million (from the erstwhile minimum of Rs 100 million). If recent media reports are to be believed, SEBI has written to AMCs asking them to merge or close debt funds with an asset size of less than Rs 200 million. Reports further suggest that equity funds with an asset size of less than Rs 100 million will be dealt with likewise.

Yet again SEBI seems convinced that investors’ interests will be better served by investing in larger funds. To be fair, larger funds offer certain advantages: all things being equal, they are structured to be more competitive on the price (read expense ratio) front versus smaller sized funds. In certain segments of the debt market, the minimum lot size is on the higher side, in turn necessitating that the fund have a reasonable asset size to be able to operate efficiently.    

But doesn’t it strike as being odd that the market regulator is now even dictating what a fund’s minimum asset size should be? Clearly, there’s more to it than meets the eye. For some time now, SEBI has been trying to make mutual fund investing less complicated for investors. Remember the risk-based colour-coding for funds, or even asking AMCs to disclose fund performance versus an appropriate benchmark index across specified time periods. To my mind, SEBI recognizes that there are too many funds available out there which makes fund selection a difficult task for investors. With this move, SEBI is in fact trying to rationalize the number of funds.

In India, AMCs have displayed a penchant for recklessly launching new fund offers (NFOs), since NFOs do act as tools of asset mobilisation. In this context, while the regulator’s intent cannot be flawed, the approach needs to be questioned. A fund’s asset size in isolation cannot be the barometer of its worthiness. Just as there are several small funds which perform and serve investors well, there are several large ones which are laggards and hurt investors’ interests.

Disallowing smaller funds en masse hardly seems like the right solution. Instead what the regulator must do is force (since they seem incapable of doing so voluntarily) accountability on AMCs. And here’s how:

1.   Make AMCs invest in all their open-ended funds:   

Extend the scope of the recent regulation whereby the concept of seed capital in open-ended NFOs has been introduced to all open-ended funds. Simply put, it should be mandatory for AMCs to invest their personal monies in all their open-ended funds. Apart from boosting the fund’s asset size, this move will (more importantly) also reveal an AMC’s true commitment to its funds. It should come as no surprise if a number of funds are voluntarily closed or merged irrespective of their asset size.

2.   Make the Board of Trustees accountable

The Board of Trustees (BoT) is required to sign off on NFOs authenticating that they are different from the AMC’s existing funds. Truth be told, not all boards have distinguished themselves, else we wouldn’t have had a proliferation of like NFOs. It’s time SEBI makes the BoT accountable by getting them to audit all existing funds on an ongoing basis with a view to weed out both weak and similar funds. The audit report, recommendations made and action taken should be a part of the annual statutory disclosure.

3.   Enhance quality of distributors

This is admittedly a long-term initiative: the Indian mutual fund industry needs more informed and better-equipped distributors. Sadly, there are a large number of well-meaning distributors who would like to do what’s right for the investor, but are ill-equipped to do so. For instance, when an AMC offers them a fund with a poor investment proposition, they are unable to see through it. The answer lies in re-visiting the criteria for empanelling distributors. Also, SEBI should mandate that a part of the monies meant for ‘investor education’ initiatives (we all know how that is really utilised J) be used for training distributors.

Finally, the market regulator must recognize that if it wishes to attract investors and build investor confidence, there is a need to make systemic changes in the mutual fund industry. Targeting smaller sized funds is unlikely to help on either count.