Should Fund Houses Fear Big-Ticket Investors?

Media reports suggest that a questionnaire from the country’s largest bank -- State Bank of India (SBI) has sent several fund houses running for cover. Apparently SBI invests substantial monies in debt mutual funds; last week, the bank sent a questionnaire to fund houses, seeking information about their investment practices and policies. Among others, SBI has asked for information on fund houses’ policy for compensating investors in the event of a loss incurred due to a default or downgrade. Clearly, the JPMorgan Mutual Fund episode continues to rankle investors.

Investors wanting to know more about a fund house’s investment practices is understandable. Indeed, one expects them to perform such due diligence before making an investment, rather than after investing. The curious part pertains to seeking compensation in the event of a loss. It doesn’t take a genius to figure out that mutual funds are market-linked instruments; hence the possibility of incurring a loss cannot be ruled out. Given that fund houses operate as pass-through structures, expecting them to compensate investors for a loss incurred in the normal course of investing seems farfetched. So why would a behemoth like SBI seek such information? For the answer, let’s step back in time.

Hail big-ticket investors!

The mutual fund industry’s fondness for big-ticket investors (institutions and high net-worth individuals) is no secret. Over the years, this liking has manifested itself in various forms: institutional plans with liberal expense and load structures (versus retail plans), launch of fixed maturity plans that enabled a handful of big-ticket investors to make quasi-PMS investments. In the 2008 meltdown, several fund houses did their best to protect large investors in debt funds, by transferring illiquid securities to equity funds. In effect, liquidity was provided to large investors at the cost of retail investors (who largely invest in equity funds). Over time, it took intervention from the market regulator SEBI (in the form of abolishing differential expense and load structures, and instituting the 20-25 rule, among others) to create a level playing field. 

But then old habits die hard. Perhaps some big-ticket investors have a sense of entitlement which leads them to believe that mutual funds should be structured as  risk-free (at least in part) investments for them.           

The counterview 

Data from AMFI reveals that as of Sep 2015, debt and liquid funds accounted for roughly 67% of mutual fund assets. In both the segments, a lion’s share (62% in debt funds and 92% in liquid funds) was held by institutional investors. Simply put, a bulk of mutual fund assets come from institutional investors. Fund houses can claim that they are obligated to offer these big-ticket investors preferential treatment. But such thinking is flawed.

Any serious fund house knows that long-term assets are the key to survival and growth. Yet again, data reveals that fund categories wherein retail investors dominate tend to display longer investment horizons versus categories wherein institutional investors dominate. Hence, it is in the interest of fund houses to offer retail investors a fair deal.

If fund houses find themselves in a vulnerable position, they must shoulder at least part of the blame for having failed to democratize investments. Several fund houses have been guilty of chasing short-term institutional monies and failing to develop a strong retail investor base.

It will be naïve to believe that any fund house will offer to compensate SBI for losses incurred in its schemes. It’s high time self-respecting fund houses send an unambiguous message: The era of offering preferential treatment to big-ticket investors (and treating retail investors as second-class citizens) is over. It is in the best interest of fund houses to come to terms with this realisation and act on it at the earliest.