FUND FULCRUM

September 2015

The mutual fund industry witnessed a drop of nearly 5% in assets under management (AUM) to Rs 12.55 lakh crore in August 2015, mainly on account of fall in inflow into such schemes. The assets base of the country's 44 fund houses declined from an all time high of Rs 13.17 lakh crore in July 2015 to Rs 12.55 lakh crore in August 2015, according to the latest data. The fall in asset base can be attributed to redemptions from investors during the month amid volatility in the stock market. Overall inflow in mutual fund schemes have fallen to Rs 1.58 lakh crore at the end of August 2015 from Rs 2.05 lakh crore at the end of July 2015. However, fund managers have purchased shares worth a staggering Rs 10,533 crore in August 2015 even though overseas investors sold stocks worth Rs 16,877 crore during the same period — its highest monthly selloff in more than seven years. They made intensive buying in the last week of August 2015 when the domestic market crashed due to the rout in Chinese equities. The sell-off by overseas investors in the Indian equity markets has meant an opportunity to mutual fund managers. The top five mutual fund houses — HDFC, ICICI Prudential, Reliance, Birla Sun Life, and UTI AMC, which together hold about 55% market share in the mutual fund industry — have bought stocks that have been beaten down and were trading at attractive levels in August 2015. HDFC Mutual Fund bought Tata Steel and Vedanta, while ICICI Prudential bought into NTPC and Ambuja Cements. Among midcap stocks, fund houses bought stocks such as Thomas Cook, Sun TV Network, and Exide Industries.

According to data from the Association of Mutual Funds in India (AMFI), investors withdrew a net amount of Rs 46,750 crore in mutual fund schemes in August 2015. Mutual funds saw an outflow in mutual fund schemes in August 2015 mainly on account of huge redemptions in liquid and money market funds. However, investors continued to maintain their bullish stance on the equity schemes. Liquid or money market fund category witnessed Rs 70,489 crore being pulled out in August 2015, while equity and equity linked schemes saw an inflow of Rs 9,156 crore. With the latest outflow, the net inflow in the schemes was at Rs 1.58 lakh crore in the April-August period of the current fiscal, 2015-16.

Piquant Parade

C V R Rajendran, former Chairman and Managing Director of Andhra Bank, has taken charge as the new CEO of AMFI on September 16, 2015. Rajendran’s tenure as CMD at Andhra Bank ended in April 2015. Prior to this, he was the Executive Director at Bank of Maharashtra. He has held key positions in many financial institutions like Asian Development Bank, Corporation Bank, and MCX Stock Exchange. He joined banking sector in 1978 as an Officer with Corporation Bank. Earlier, AMFI had invited applications from candidates having a minimum experience of 25 years in the financial markets with at least 5 years of experience in a role of a CEO or whole time director before June 1, 2015. 

AMFI is running advertisements, on television, which urge people to use mutual funds to diversify their investments. The advertisements went on air on August 22, which coincides with AMFI completing 20 years of operation. The campaign is being aired on general entertainment and news channels. AMFI is also planning to communicate this message through print media and FM channels. AMFI said that the pan-India campaign is being aired on TV in 13 languages. AMFI will roll out the print and digital campaign soon. AMFI had earlier run a TV campaign ‘Savings ka naya tareeka’ in September 2011 for five weeks. The budget for this campaign was estimated to be Rs. 8 crore. Apart from television commercials, AMFI had developed a 36 page booklet to explain the basics of mutual funds. Over 30,000 SMSes enquiries about mutual funds were generated within four weeks of running these ads on national television channels. The initiative is the brainchild of AMFI Financial Literacy Committee. 

Sahara Mutual Fund, which has been ordered by the Securities and Exchange Board of India (SEBI) to transfer its asset management business to a new fund house by December 2015, is unlikely to find a buyer as fears of litigation and regulatory issues keep fund houses away. The fund house has been scouting for a buyer through various investment bankers but existing entities are sceptical of acquiring it due to potential liabilities that may come along with the fund, which could impact the overseas fund-raising activities of the acquiring entity. The fund has limited AUM of around Rs.130 crore. 

Regulatory Rigmarole

In its report published to recommend measures for curbing mis-selling and rationalizing distribution incentives in financial products, the nine-member committee headed by Sumit Bose, former Union Finance Secretary has recommended that fund houses should not pay any upfront commission to distributors for selling mutual funds. Further, the committee has recommended that the commissions should only be paid on reducing AUM based trail. For instance, in case of lump sum investments, the trail will decline over the tenure of investment and become nil after a certain period of time. Besides, the committee has said that B15 distributors should not get higher commission. It said that AMCs themselves should tap such unexplored markets to increase their market share. SEBI has allowed AMCs to charge a higher TER for sourcing applications from B15 cities. Currently, distributors from B15 cities are exempted from the current 1% cap on upfront commission imposed by AMFI. The committee has also recommended that SEBI should lower the cost caps (within the TER) with the growth in AUM. Besides, it has also recommended that fungibility within the TER should be done away with. The committee has recommended measures in three areas – commissions, product structure, and disclosures. Recommendations related to product structure: Merge similar schemes to reduce confusion among investors. Benchmarks should be made more relevant and schemes should be periodically tested to see if the asset allocation is conforming to the benchmarks. Schemes should remain true to label. Promote ETFs among retail investors. Similar to insurance, introduce free look policy in mutual funds. Recommendations on disclosure: Penalize distributors pitching NFOs as cheap products on the basis of highlighting NAV “at par” value of Rs.10. Disclose past returns (along with benchmark returns) of schemes while selling products. Investors should be disclosed a range of past returns appropriate to the product tenure and should include returns of last 6 months and annualized returns since inception and 2 year returns thereafter. Disclose trail commission to investors at the time of sale. In addition to the disclosure of scheme performance subject to market risk, put additional disclosure stating that the fund’s performance is subject to fund house/manager’s competence. Inform all investors when fund manager of a scheme changes. The AUM rankings published by AMCs on their websites, information memorandum, etc. are presently combined for all products which give a misleading picture. For retail products, the AUM rankings should be shown only for the retail AUM. The committee has also recommended that there can be various regulators for the same product keeping in view the different functions of the product. For instance, it wants SEBI to regulate the investments made by Ulip funds, while IRDA to regulate the insurance part of the same fund. Currently, Ulips are regulated by the insurance regulator IRDA, while mutual funds are controlled by the markets regulator SEBI.

AMFI is planning to cut expense ratio by 30 basis points by October 2016. So, investors from smaller towns may have to pay less for investing in mutual funds. Besides, it is planning to do away with the current practice of disclosing overall AUM by fund houses and restrict it to only retail AUM. The development comes following the Sumit Bose Report. In the letter, AMFI has asked asset management companies to voluntarily bring down the expense ratio in centres outside the top 15 cities, called B-15 cities. The industry body has proposed to slash expense ratio by 10 basis points, effective October 1, 2015 followed by another 10 basis points reduction, effective April 1, 2016 and further 10 basis points, effective October 1, 2016. The removal of extra commission in B-15 centres will help in creating a level-playing field and maximize returns for investors. 

AMFI has said that AMCs should not pay any marketing support expense which would be surrogate for upfront commission. AMFI has issued a revised best practice circular on September 11, 2015 related to commission payouts. AMFI has clarified that meetings/training programs for sub-brokers/RMs of a distributor will not be considered as marketing support expense. However, these expenses should be incurred only for the event and should be executed by the AMC. AMCs are not supposed to make any payment to distributors for these events. In addition, gifts and advertisements on websites/publications of a distributor will be excluded from marketing support expense. AMFI has said that AMCs should not pay any marketing support expense which would be surrogate for upfront commission or advancing of trail. Also, it said that all expense incurred during marketing support should be backed with necessary documents/evidence. The total marketing support expense per distributor per scheme should be within the total surplus (distributable TER less upfront less trail of all transactions for the year). In order to calculate the expense incurred on distributors, the circular says that if expense is identified to a particular scheme, it should be divided by the gross mobilization of the distributor for that scheme. If not, it should be divided by the gross mobilization of the distributor across schemes (excluding liquid and ultra-short term bond category).  AMFI has also revised guidelines relating to upfront and trail commission. It has clarified that trail and upfront commission already paid by AMCs should not exceed the distributable TER. For instance, if upfront commission paid is 1% and assuming the trail commences from 5th month at 75 basis points, the total commission paid would be considered as 1.75% in the first year, which needs to be within distributable TER. Further, the trail commission in subsequent years cannot exceed 75 basis points. Further, the trail fee for subsequent years should be less than the distributable TER. Distributable TER is gross TER minus operating expense. AMFI has also issued clarification regarding operational implementation of commission payout in ELSS, RGESS, and retirement plans which qualify for tax deduction under section 80C and 80CCG of the Income Tax Act 1956. For instance, in ELSS, no trail commission will be paid for 36 months (if 1% advance upfront is paid for a period of 3 years). Also, for the 37^th month, the trail fee can be up to distributable TER less upfront commission. On the B15 commission payouts, the revised clause says that the ‘additional’ payout for B15 locations at scheme level for any financial year should be within the B-15 expenses accrued to the scheme. SEBI has allowed AMCs to charge additional TER of up to 30 basis points on daily net assets of the scheme if the new inflows from beyond top 15 cities are at least (a) 30% of gross new inflows in the scheme or (b) 15% of the average assets under management (year to date) of the scheme, whichever is higher. Besides, IAP expense (two basis points) will now be a part of scheme operating expense. The Board of Directors of AMCs will have to confirm to AMFI on a yearly basis that they have adhered to these guidelines.

Market watchdog SEBI has advised fund houses to reassess their risk management policy related to fixed income schemes. In an email sent to AMC CEOs on September 11, the regulator advised fund houses to reduce concentration risk in their fixed income portfolios. SEBI has also asked fund houses not to rely only on external research/ratings and recommended them to do their own research before buying any instrument.

In its latest best practices circular, AMFI has asked AMCs to gather the missing KYC information from investors and ensure that all investors have undergone IPV (in-person verification). IPV means that information provided in the KYC form has to be verified in-person by distributors. Earlier, AMFI had asked distributors to collect missing KYC information from investors who had undergone KYC registration before January 1, 2012. The missing KYC details includes (for individual investors) name of father/spouse, marital status, nationality and gross annual income/latest net worth, etc. In addition, IPV was made mandatory from 2012. Apart from distributors, IPV can be done by employees of AMCs, R&Ts, and authorized officials of commercial banks (only in case of direct applications). So far, AMCs were accepting transactions even if IPV was not done by distributors. From January 2016, AMCs will not accept incomplete applications (where KYC is done and IPV is incomplete). For ease of doing IPV, SEBI has allowed distributors to perform IPV through web camera. SIP and STP mandates already registered till December 2015 are exempted from this requirement.   AMFI has urged distributors to make sustained efforts to obtain missing KYC information and complete IPV and updated the same in KYC Registration Agency (KRA) records till December 2015.  AMFI has directed AMCs to reject applications from November 2015 if KYC status is ‘deactivated’, ‘not available’, and ‘rejected’. If investors KYC status is ‘on hold’ then AMCs and RTAs need to intimate investors and get it rectified. From November 1, 2015, AMCs will reject all purchase and switch transactions if the missing information is not complete. From January 01, 2016, AMCs will reject all purchases and switch transactions if the missing KYC information is not provided and IPV is not completed. Distributors have to make sure that they have performed IPV till December 31^st and update missing KYC information by 31^st October 2015.

Paving way for active fund management in National Pension System (NPS), PFRDA has allowed pension fund managers (PFMs) to invest NPS corpus in mutual funds. PFMs can now invest pension corpus in large cap equity funds, ETFs that track index, gilt funds, income funds, and liquid funds. NPS is a voluntary pension scheme launched by PFRDA which aims to provide pension to people in both the organized and unorganized sectors. Currently, there are three schemes under NPS – gilt, fixed income, and equity. NPS can deploy up to 50% corpus in equities depending on the type of scheme or age of subscribers. In its investment guidelines, PFRDA has allowed PFMs to invest in mutual funds having at least 65% exposure to large cap stocks. The pension fund regulator has also allowed PFMs to take equity exposure through low cost index ETFs and CPSE ETFs. However, PFMs can also deploy NPS corpus in shares having a minimum market capitalisation of Rs.5,000 crore on their own. In addition, PFMs are allowed to invest in income funds, gilt funds, and liquid funds to take exposure to debt instruments. The move will help the mutual fund industry to position itself as a long term investment vehicle, besides helping to increase the AUM of the mutual fund industry.

According to a recent Cafemutual report called ‘Mutual Funds in India Being Future Ready’ an analysis of RBI and AMFI data shows that the AUM of mutual fund industry is likely to reach Rs.20 lakh crore in the next three years. This translates to a growth of 19% i.e. from Rs. 12 lakh crore in 2015 to Rs.20 lakh crore in 2018. Factors like increasing awareness among investors about mutual funds, government’s initiative on financial inclusion and growing population of young investors will help mutual fund industry achieve this growth. The Indian mutual fund industry is in a sweet spot with all the enabling ingredients in place. While a sound macroeconomic environment and favourable demographics ensure availability of long-term capital inflow, a proactive and conductive regulatory regime facilitates the industry’s growth. Surprisingly, the report has found that Indian mutual fund industry has outpaced global mutual funds in terms of AUM growth. AUM of the Indian mutual fund industry has grown at a CAGR of 17% compared to the global average of only 9% since 2008. Strong fundamentals of the Indian economy helped cushion the Indian financial markets against the global financial crisis. B15 centers will be the key growth driver for the mutual fund industry. Fuelled by robust farm growth, rising rural wages and increased government spending, the B15 centers have shown commendable growth and are likely to maintain this pace.