Mumbai: Securities market regulator Sebi is in the process of firming up a policy to push retail participation in mutual funds (MFs), in an effort to neutralise or lower the impact of large outflows by corporate or institutional investors, as was the case recently.
The regulator is now weighing the option of segregating corporate and retail investments so that small investors are not affected if corporates exit early, a person familiar with the matter said. This could mean that fund houses would be told to float separate schemes targeting institutional and retail investors, a practice that is prevalent overseas. “In such a scenario, if a large corporate investor pulls out money from a scheme, only other corporate investors need to worry and not retail investors, as is the case now,” said a person close to the development. Sebi is in talks with MFs to address the issue that has exposed the weak links in the financial sector. The trigger for the proposed changes is the developments last month. The MF industry was rocked last month after large corporate investors pulled out some of their investments in debt schemes due to a liquidity crunch that gripped the financial markets and also on concerns related to the credit quality of debt paper in some fixed maturity plans floated by fund houses. The redemptions, coupled with the value erosion in the portfolio of schemes due to the battering of stocks, led to a steep fall of close to Rs 97,000 crore in the assets under management (AUMs) of the industry from Rs 5,29,000 crore in September to a little over Rs 4,31,000 crore in October—a period during which most fund houses witnessed redemptions of 20% on an average.
The large redemptions by corporate investors had put some fund houses under severe pressure, prompting the central bank to open a special facility for banks to lend to asset management companies to meet their redemption needs.
Corporate investors not penalised for exiting early
This has raised concerns within the policy establishment in India on the impact that large corporate or institutional investors can have on mutual fund schemes if they choose to pull out money prematurely. Such a move by large investors leaves retail investors—for whom mutual funds were designed as an investment vehicle—vulnerable, without severely penalising corporate investors who exit early. According to one estimate, corporate investors account for a little under 55% of the total AUMs of mutual funds. These investments are spread mainly across short-term products such as liquid or liquidity plus schemes that invest mainly in gilts and other securities and FMPs, where the investment is in pass through certificates issued by realty firms, commercial paper and debentures.
The regulators worries centre around the fact that such a substantial share of institutional money in mutual funds if pulled out abruptly can cause instability and dent the confidence of investors. "This is an issue on the table and we are weighing some options," an official who did not want to be identified said. Sebi has already stopped approving fresh filings for FMPs that provide an early exit clause to investors. The disproportionate share of corporate funds in MFs can be attributed to the tax arbitrage opportunity on offer. For investors in FMPs, the tax incidence works out to a little over 22% in the long term while investments in safe avenues such as fixed deposits are taxed at a higher rate. Fund houses also provide a lot of incentives to corporate investors in terms of entry loads and other benefits to grow their assets. This helps them boost their AUMs and, in turn, valuations. Since many asset management companies do not invest in a distribution network, corporate money comes in handy.
This is reflected in the fact that at least 80% of the retail assets of Indian mutual funds is accounted for by eight major cities and towns in India. And of the total assets of the industry, equity schemes account for just about one-third with debt schemes making up for the bulk of it. Corporate money in equity schemes is reckoned to be just under 5%. The chief of an AMC said once the taxation arbitrage issue is addressed, the industry would fall on track as that would discourage corporates from investing and force fund houses to extend their distribution network and reach out to retail investors.
