What Executive Remuneration Disclosures Reveal About Fund Companies

In March 2016, SEBI issued a circular mandating that the remuneration of every fund company’s top brass be disclosed. Apart from the remuneration of the CEO, CIO and COO, the circular requires that fund companies publish a list of employees whose annual remuneration is equal to or above INR 6 million, and also the ratio of CEO's remuneration to median remuneration of employees.

Some fund companies have recently released the requisite information on their websites. In an earlier post, I had expressed reservations regarding the utility of these disclosures. Interestingly, the manner in which disclosures have been made, has unintentionally revealed more than the disclosures themselves.

To begin with, despite the deadline not all fund companies have made the relevant disclosures at the time this post was written. Perhaps SEBI-mandated disclosures aren’t important for some fund companies.

At their core, the said disclosures are intended at empowering investors. Hence it would be reasonable to assume that investors should be able to easily access them. Is that the case? Let’s find out.

Of the top 10 fund companies (which account for roughly 80% of industry assets; read substantial investor interest), four—Birla Sun Life Mutual Fund, SBI Mutual Fund, UTI Mutual Fund and Franklin Templeton Mutual Fund—haven’t disclosed executive remuneration as yet.

A common thread running through the balance six fund companies is that only existing investors can access the information. In other words, a prospective investor who may want to use the information to make an investment decision is unable to do so.

Furthermore, before accessing the information, investors are required to agree to a long list of terms and conditions which among others, state that the information shall not be shared with anyone in any form or manner. In other words, the disclosures are confidential in nature; oxymoron anyone?

Now let’s delve into how fund companies fare in terms of accessibility of disclosures. Of the top 10, HDFC Mutual Fund fares well. Investors can access the requisite information after entering two data points and a CAPTCHA. All the information is available on a single web page, and can be easily copied into other user-friendly formats.

Accessing data on Reliance Mutual Fund’s website is trickier. It helps to have a registered mobile number which can be used to generate a One Time Password. Alternatively, a combination of two or more data points are required. While the information is available in a single web page view, it cannot be copied into another format.

ICICI Prudential Mutual Fund fares worse offering access to only one executive’s remuneration at a time. In other words, one needs to tediously move back and forth to access multiple data points.

While accessing information from IDFC Mutual Fund requires two data points and a CAPTCHA, Kotak Mutual Fund demands six data points.

DSP BlackRock Mutual Fund holds the dubious distinction for being most secretive while disclosing executive remuneration. Data entered on the website leads to an auto-generated mail being triggered to the investor’s registered email-id. Clicking on a link therein takes the user to a webpage wherein the investor can request for one executive’s remuneration at a time. Following this a message flashes “Your request for information has been registered. Our Human Resources team will reply to you shortly”. I am yet to receive any information despite passage of over 24 hours.

However not all fund companies fail to pass muster. Two of the smallest fund companies—Quantum Mutual Fund and PPFAS Mutual Fund—have followed the disclosure norm in letter and spirit. Not only is executive remuneration-related information freely available on their websites (in other words, one need not be an investor to access the information), the information can be conveniently accessed in the PDF format. 

It’s quite likely that in the days to come, SEBI may issue guidelines standardising the manner in which executive information must be disclosed. However at present, when fund companies are using their discretion to disclose information, speaks volumes about their attitude towards investors.

Why Investors Must Cheer SEBI’s Initiative On Mutual Fund Disclosures

Last week, market regulator SEBI released a circular that among others, enhances mutual fund disclosures. The new directives have the potential to be game changers.

Let’s start off with the disclosure that has garnered most attention—commission paid to distributors. SEBI has ruled that henceforth half-yearly account statements sent to investors will have information regarding commission paid to distributors. Commission has been defined to include both monetary and non-monetary payments made by the fund company to the distributor. Furthermore, the statement will also have information regarding expense ratios (for both regular and direct plans).   

Some quarters are up in arms against this ruling. While some feel that disclosing commission-related information will push investors towards direct plans, others argue that this is a conspiracy to ease out small distributors. I believe the reservations are a case of stretching the point.

Fund companies pay commissions to distributors for selling their products (and rightly so!); all they need to do is disclose the same to investors (who bear the cost). No one’s suggesting that fund companies must stop compensating distributors. Also, to assume that an investor who is satisfied with his distributor’s service, will turn his back on the same and opt for a direct plan, because the commission is disclosed is a fallacious argument. So long as the distributor adds value, the investor will continue to be associated with him.

In the confusion, most have overlooked what to my mind is the most important ruling—investments in funds by portfolio managers and other personnel. From May 2016, every fund’s Scheme Information Document (SID) will have information related to investments made by the fund’s portfolio manager(s), the AMC’s Board of Directors and other key managerial personnel.

The rationale behind this move is to encourage the concept of ‘skin in the game’. The concept is far more common in the West, than in India. For instance since 2005, the U.S. Securities and Exchange Commission has required fund companies to annually disclose how much portfolio managers invested in the funds they run. At its core, 'skin in the game' is about inspiring confidence in investors. Managers who invest alongside their investors show conviction in their investment approach and acumen. It’s a classic example of putting one’s money where the mouth is. This regulation offers investors insights into funds, and the opportunity to evaluate them in a manner hitherto unavailable.

Then there’s the directive on soft-dollar arrangements. So far, investors have been blissfully unaware of soft-dollar arrangements between fund companies and brokers, and how the same impacted their investments. SEBI has decided that henceforth, soft-dollar arrangements will be limited to benefits that are in the interest of investors, and the same shall be disclosed.

Admittedly, some rules seem odd—it has been mandated that compensation of the fund company’s top brass be disclosed. Likewise, fund companies will have to publish a list of employees whose annual remuneration is equal to above INR 6 million, and also the ratio of CEO's remuneration to median remuneration of employees. I fail to see how these provisions can help investors make better investment decisions. Investors’ interests would have been better served if the method of computing annual remuneration had been disclosed. That way, investors could have comprehended what fund company top bosses are mainly compensated for—growing assets or fund performance.

That said, all in all, the mandated disclosures have the potential to usher in an era of transparency in the mutual fund industry. However, one must understand that a disclosure (read transparency) isn’t an end in itself. Learning more about funds should translate into informed investment decisions, and in turn, goals being achieved. The onus to make the most of the information on hand, lies on investors, advisers and distributors alike.

Why Indian Fund Companies Shouldn’t Fear Greater Transparency

Media reports suggest that several Indian fund companies are at loggerheads with market regulator SEBI. The latter wants to increase transparency by disclosing commissions paid to distributors in investors’ statements of accounts. On the other hand, fund companies believe that doing so will be detrimental to their interests. According to reports, industry body AMFI has communicated its reservations to the regulator.

Reasons for opposing the move are varied: some fund companies think disclosing commission-related information will dissuade investors. Others feel that bombarding investors with too much information will be detrimental. 

To my mind, the concerns raised by fund companies are both misplaced and weak. To begin with, the proposal doesn’t alter the working of the fund industry in any manner. Fund companies pay commissions to distributors for selling their products (and rightly so!); all they need to do is disclose the same to investors (who bear the cost). No one’s suggesting that fund companies should stop compensating distributors.

As for fears of investors becoming upset by learning about commission payments, or becoming confused on account of too much information—those are weak arguments. Fund companies would do well not to underestimate the investor’s intellect. To assume that an investor who is satisfied with his investment will turn his back on it, because the agent’s commission is disclosed is a fallacious argument.

When an investor invests in a mutual fund, effectively he engages a fund company to manage his monies. The fund company charges a TER (comprising everything from operational expenses, the fund company’s fees, to the distributor’s commission) for the service. An unambiguous disclosure will aid investors better understand the fund’s working, and thereby make informed investment decisions.

For instance, a fund company which keeps costs (including fees and commissions) low and thereby enhances the fund's returns can benefit by communicating the same to investors. It can be safely stated that such disclosures will go a long way in winning investors’ patronage.  Conversely, the investor has a right to know if his fund is losing its competitive edge on account of exorbitant commission pay-outs.

Case for more disclosures

I’m surprised that in its quest for greater transparency, SEBI didn’t start at the top of the pyramid i.e. with fund companies. There is a strong case for making public, information related to the fund company’s compensation policy for its investment staff (portfolio managers and analysts), and also information regarding a portfolio manager’s personal investments in funds he runs.

Taken together, the two can reveal a lot about the fund company’s culture, its attitude towards investors, and a manager’s commitment to his fund—all of which can be vital in helping investors make better decisions. 

Admittedly, from the perspective of fund companies, revealing information that hitherto was private can be discomforting. But it is in their interest to embrace this change. Greater transparency isn’t an end in itself. The intent is to improve investors’ investment experience, and in turn make mutual funds more appealing. And when the investor wins, so will fund companies.

Let Portfolio Managers Eat Their Cooking, But Don’t Force-Feed Them

It has been reported in the media that Kotak Mahindra Asset Management Company (AMC) has ruled that its employees who wish to invest in mutual funds, shall henceforth do so only in the AMC’s funds. The reports also suggest that employees will be penalized if they make fresh investments in funds from other AMCs after the policy comes into place. 

The rationale behind the move is to introduce the concept of ‘skin in the game’. The concept is far more common in the West, than in India. For instance since 2005, the U.S. Securities and Exchange Commission has required AMCS to annually disclose how much portfolio managers invested in the funds they run. 

To clarify, Kotak Mahindra AMC is not the first Indian AMC to institute a ‘skin in the game’ policy. While some AMCs pay (a part of) bonuses to their investment teams in the form of mutual fund units, others pledge that their top brass invest in funds from the AMC. What differentiates Kotak Mahindra AMC’s guideline is that perhaps for the first time, employees across the board who wish to invest in mutual funds, have been told to compulsorily do so, in the AMC’s funds. 

Why ‘skin in the game’ matters 

From an investor’s perspective, is Kotak Mahindra AMC’s guideline necessarily a positive one? I don’t think so.

To clarify, I have been a propagator of portfolio managers eating their cooking i.e. investing in funds they run for a while now; also, I believe there is a case for disclosing managers’ investments in funds they run. To understand why I am not convinced of the guideline in question, let’s delve further into the ‘skin in the game’ concept. 

At its core, portfolio managers investing in mutual funds they run is all about inspiring confidence in investors. Portfolio managers who invest alongside their investors show a conviction in their investment approach and a confidence in their investment acumen. It’s a classic example of putting one’s money where the mouth is.

Coercion versus free will

The trouble with Kotak Mahindra AMC’s policy is that there is an element of coercion. Employees (including portfolio managers and analysts) who wish to invest in mutual funds, will invest in funds from the AMC because they are being forced to do so, not because they want to. For an act to inspire confidence, it must be voluntary and not compulsory. Even if managers claim that they have invested in funds from the AMC voluntarily, that argument is unlikely to find many takers, given the existence of a policy which dictates such investments.

What AMCs must do

  

If Indian AMCs are serious about building investor confidence, they must adopt the ‘skin in the game’ concept in letter and spirit. Apart from voluntary investments by portfolio managers, AMCs can explore avenues such as offering a part of the compensation in locked-in units from the AMC’s funds, or periodically disclose investments made by managers in funds they run. 

Most importantly, AMCs must appreciate the importance of free will for ‘skin in the game’ to have the desired effect.

Will Offshore Funds Prove to be the Domestic Mutual Fund Investor’s Achilles’ heel?

Earlier this month, market regulator SEBI released a document titled “Consultative paper on managing/advising of Offshore Pooled Assets by Local Mutual Fund Managers”. The paper makes a case for removing certain restrictions existing under section 24(b) of the SEBI (Mutual Funds) Regulations Act.

At present, if an Indian asset management company (AMC) wants to manage or advise offshore pooled assets or funds, and for the purpose appoint a fund manager who is currently managing its domestic funds, the AMC can do so subject to: both domestic and offshore funds having the same investment objective and asset allocation. Furthermore, both portfolios must have a commonality in holdings of at least 70%; finally, the offshore fund must pass muster on the 20/25 rule applicable to domestic mutual funds. SEBI has proposed that for offshore assets classifying as Foreign Portfolio Investors (FPI) investments these restrictions be scrapped.

It’s not difficult to understand what’s driving SEBI. For a better part of the last five years, the domestic mutual fund industry has struggled to clock a healthy growth in terms of assets under management. With expectations of a strong economic revival and buoyant markets, India has resurfaced on global investors’ radar. The opportunity to freely manage/advice global funds can prove to be a significant opportunity for Indian AMCs.

To be fair, the present set of regulations though well-intended (more on that later) were restrictive for Indian AMCs. Let’s take an example to better understand this. Consider a global fund house which wants to launch an India-dedicated fund and hand its reins to a domestic AMC, which in turn has a skilled fund manager with a proven long-term track record. Expectedly, the global AMC would want it’s monies to be managed by the same fund manager. His track record and presence will be the new fund’s USP. However, the present set of restrictions (especially ones related to 70% commonality in holdings and the 20/25 rule) made it operationally difficult to have the Indian fund manager at the global fund’s helm.

Conflict of interest

If the aforementioned restrictions are done away with, life will become significantly easier for both Indian AMCs and fund managers. However, the flipside is that it could lead to a potential conflict of interest situation with domestic investors on one side and investors in global funds on the other. Global funds, by virtue of their asset size can prove to be lucrative for Indian AMCs, and the possibility of fund managers paying more attention to these funds at the cost of domestic funds cannot be ruled out.

Even SEBI recognizes this prospect and has provisions wherein AMCs are required to make a disclosure in the scheme information document (SID) that there exists no material conflict of interest across its activities and other like measures. Perhaps some of the restrictions which are now proposed to be scrapped had their origins in protecting domestic investors’ interests.

A quick glance at how AMCs reacted to these restrictions in the first place reveals a lot. There were cases of AMCs withdrawing their leading fund managers from domestic funds and instead utilising them to run/advice offshore funds. To placate distributors and investors in India, a standard (but off-the-record) refrain was that though the said managers no longer run domestic funds, they do ‘influence’ the local strategy. In 2011, when SEBI came up with the present set of regulations permitting managers to be named on both domestic and offshore funds, while some of the 'absent' managers returned, others yet chose not to do so. All in all, it isn’t difficult to see which piece of the pie Indian AMCs prefer.

Skin in the game

Admittedly, there is no foolproof method to ensure that domestic investors’ interests are not compromised. But what SEBI can do is institute a framework which prods AMCs and fund managers to act in a fair manner. To begin with, provisions requiring AMCs to invest its personal monies in new fund offers must be expanded to include all its domestic funds. Furthermore, SEBI should make it mandatory for fund managers to invest in every domestic fund helmed by them. Ensuring that AMCs and managers have their skin in the game, is perhaps the best way of ensuring that domestic funds aren’t neglected. Also, these investment must be periodically disclosed.

Another disclosure which will help is that of performance and portfolios of offshore funds being managed/advised by fund managers. This will help domestic investors track and compare the manager’s activities on offshore funds versus domestic funds. 

At their core, these measures can go a long way in revealing the true character of AMCs and fund managers. Using the former as inputs, the onus of making informed choices will rest with investors.