FUND FULCRUM (contd.)

September 2014

The top ten equity funds account for 34% or Rs. 80,300 crore of the total Rs. 2.35 lakh crore managed by the 300 plus equity mutual funds in India as on August 2014, according to a Motilal Oswal Securities report. HDFC Equity Fund and HDFC Top 200 are the largest funds in the industry which together manage assets of Rs. 28,800 crore. While HDFC Equity Fund (India’s largest fund in terms of size) has an AUM of Rs. 15,800 crore, HDFC Top 200 manages Rs.13,000 crore. Both these funds have significantly outperformed their benchmark during the five year period. Value Research data shows that HDFC Equity Fund and HDFC Top 200 have delivered CAGR of 17% and 15% respectively in five years against the 10% CAGR of their respective benchmarks. This was followed by Reliance Equity Opportunities Fund and ICICI Prudential Focussed Bluechip Equity Fund which manage AUMs of Rs. 8,100 crore and Rs.7,300 crore, respectively. While Reliance Equity Opportunities Fund has delivered 22% CAGR, ICICI Prudential Focussed Bluechip Equity Fund has given a CAGR of 17% in five years, according to Value Research online. Both HDFC Mutual Fund and ICICI Prudential Mutual Fund have three funds each in the list of top 10 equity funds. Other fund houses - Reliance, Birla Sun Life, IDFC, and Franklin Templeton have one fund each in the list.

Regulatory Rigmarole

Fund houses have started collecting necessary information from foreign investors about their tax residency status in order to comply with the requirement of Foreign Account Tax Compliance Act (FATCA) provision. The FATCA regulations is an anti-tax evasion law for which fund houses are required to report information on US investors to US IRS (Internal Revenue Service) through CBDT. India has agreed ‘in substance’ to FATCA by signing an Intergovernmental Agreement (IGA) with US in effect from April 11, 2014. Simply put, the legislation is meant to prevent wealthy US individuals from parking money overseas to avoid paying taxes. As a part of due diligence, the fund houses have asked foreign investors particularly from USA and the distributors who have clients from the USA to furnish documentary evidences of tax residency and other information. In July 2013, SEBI had asked fund houses to register with US by December 2013 and obtain a Global Intermediary Identification Number (GIIN). Following this, many fund houses had temporarily stopped accepting fresh investments from US residents.

In order to safeguard Indian markets from any manipulative research reports, SEBI has notified norms for 'research analysts' to remove any conflict of interest in their activities. Foreign entities acting as research analysts for Indian markets or India-listed companies would need to tie-up with a registered entity in India, while domestic players would also be subjected to strict disclosures and scrutiny. The new norms would also cover those providing advisory services similar to research analysts. These new norms would be called the Securities and Exchange Board of India (Research Analysts) Regulations, 2014. These regulations shall come into force on the 19th day from the date of their publication in the Official Gazette. According to new norms, every individual or entity desiring to function as a research analyst would need to get registered after meeting the prescribed criteria regarding qualifications and capital adequacy among others.

The Securities and Exchange Board of India wants to bring domestic and foreign portfolio investors at par on know your client norms in order to facilitate framing of rules based on investor risk profiles. In its draft circular seeking responses, the capital market regulator has proposed that the new structure will have KYC norms for domestic investors, both individual and institutional, based on their potential to bear risks — low, medium and high. The existing system of KYC norms prescribes for two categories — individual and non-individual (institutional) — in the domestic investor segment. Fulfilment of KYC norms is mandatory for investment in the capital market. The market intermediary will categorise the investors based on its risk management policy. The policy will define the norms for categorisation of the investors. Once the category is decided, minimum documents for KYC will be collected from the investors. However, the intermediary will be free to ask for additional documents from any category of investors. In the proposed structure, investors with lower risk will have to submit lesser number of documents and vice versa. But, if the investor is also trading in the derivative segment (futures and options or F&O), he will have to submit documents to ascertain his/her financial position in addition to documents required for KYC. A standard account opening form was prescribed by SEBI on December 26, 2013, for both domestic investor categories. For all individual investors, it sought permanent account number (PAN) and Aadhaar (if the applicant has one) accounts along with proofs of identity and address. For non-individual or institutional investors, the applicant is required to provide PAN and registration number such as CIN (corporate identification number), residential address and photograph of promoters/ partners/ karta/ trustees and whole-time directors. DIN (director identification number) of whole time directors and Aadhar number of promoters and partners are also required to be submitted. The draft has also prescribed additional norms for investors participating in F&O trading in the equity market. In case of individual investors, the market intermediary can ask for a three-month bank statement (against the current norm of six months), salary slip, copy of Form 16, and copy of demat account holding statements. This in the long-term, not just for asset classification but also for investors and market participants, will lead to a much better risk assessment of the capital market for the regulator.

The Securities and Exchange Board of India (SEBI) plans to make it mandatory for issuers to reserve 25% of an initial public offering (IPO) for domestic mutual funds and insurers. However, if investors do not subscribe to their portion fully, the IPO could be considered a failure. According to SEBI, a higher participation of 25% of the issue size or half of that slotted for qualified institutional bidders would enable a fairer valuation. Besides, it will benefit both issuers and investors as these local institutional investors play the conservative card when it comes to pricing, aligning more with retail investors. At present, the issuer allots 50% of the shares in an IPO to QIBs, which include overseas and domestic funds, 15% to non-institutional investors, including high net worth individuals and corporates, and 35% to retail investors.

AMFI has asked AMCs to avoid the practice of intimating distributors and investors in advance about dividend and bonus announcements. The industry body has said that AMCs should follow the rule in its true spirit. This has come in the wake of a sudden spurt in the demand of dividend and bonus option in mutual funds. Post the changes in tax structure of debt funds, arbitrage funds gained popularity because of their tax efficiency. Few fund houses like JM Financial and Religare Invesco introduced an annual bonus option in their arbitrage funds.

In a bid to prevent money laundering, fund houses are supposed to identify ultimate beneficial owners (UBO) in the case of non-individual investors (listed companies are exempted) as part of the SEBI guidelines pertaining to anti money laundering. SEBI defines UBO as the natural person or persons, who ultimately own, control or influence a client and/or persons on whose behalf a transaction is being conducted, and includes a person who exercises ultimate effective control over a legal person or arrangement. Investors such as unlisted companies, unincorporated association / body of individuals, trusts, limited liability partnerships, religious trusts, etc. are required to furnish details regarding UBO. Individuals, listed companies, foreign investors, are not required to comply with this rule. Non individual investors have to furnish PAN along with filled up UBO form. UBO forms can be downloaded from AMC websites. A KYC acknowledgement copy has to be submitted along with the UBO form. In this form, quoting the relevant UB code (10 UB codes have been prescribed by SEBI) is mandatory.

According to a circular issued by SEBI, mutual fund houses are subject to trading member level position limits on investments in Government bond futures. The capital market regulator has said that each fund scheme would have to separately comply with client level restrictions on the instrument. Trading members are allowed to have gross open positions of 10% of the total open interest of a bond future or Rs. 6 billion ($98.10 million), whichever is higher. Client level restrictions are capped at 3% of open interest or Rs. 2 billion at present, whichever is higher.

Consolidation in the mutual fund sector could see a few fund houses getting disproportionately higher assets and thereby raise the concentration risk. The sector has seen exit of three fund houses —Morgan Stanley, ING, and Pine Bridge Investments — in nine months. Daiwa and Fidelity also have exited in recent years. The tightening of regulations and lack of profitability forced several fund houses to close. The top 10 mutual fund houses managed 80% of the sector’s assets and more entities could be exiting. A large number of assets managed by a few entities would mean a fewer number of fund managers managing a larger number of investors’ money. Investors should have more of a choice. The recent increase in the net worth requirement from Rs 10 crore to Rs 50 crore has made it difficult for the smaller entities. Their promoters are uncertain about putting more money into the business at a time when business prospects are difficult. More than half the AMCs do not generate profits at present. According to smaller entities, the dominant players, with their distribution network and deep pockets, are difficult to combat. Currently, there are 45 entities in the sector, managing a corpus of a little over Rs 10 lakh crore. The top five — HDFC, ICICI Prudential, Reliance, Birla Sun Life and UTI — collectively have an asset size of Rs 5.4 lakh crore, nearly 55% of the total assets under management.