MFs help HNIs make a daily pile

Faster entry / exit facility impacting returns of long-term investors

Mutual funds seem to be 'accommodating' high networth investors by providing faster entry and exit facility, which in international parlance is called 'market timing'.

Under the system, an investor can enter and exit a mutual fund virtually on the same day or on a T+1 basis. To facilitate this, MFs enter into hand delivery trades with brokers, which entails immediate handing over of cash. This kind of facility, however, impacts long-term investors, especially those who buy and hold units for a long time.

There is nothing in the mutual fund regulations of the Securities and Exchange Board of India (Sebi) which bars this practice, except short sales.

The mechanism is simple. A large investor puts in around Rs 10 crore before 10:30 am and then when the cheque is cleared, he is allotted the units at the previous day's net asset value.

Later on during the day if the investor wants to exit, the fund accommodates by spot or hand-delivery of shares to its broker, gets the cash and pays the investor.

This actually lowers the cost for mutual funds. The T+1 transaction works on similar lines, except the exit happens on the following day.

Also Sebi regulations do not actually prohibit a fund from delivering shares to an intermediary since under the screen-based trading the identity or nature of the buying party can be anonymous. So the fund is selling even if there is no actual counterparty on the other side.

Indirectly the broker is acutally providing low-cost funding to the fund house to facilitate redemption by the investor. Theoretically, an investor can do a number of rapid entries and exits in a single day, provided the fund is willing.

While big-ticket investors have always been given preferential treatment by fund houses, the ritual has gained currency in the ongoing boom in the equity markets.

According to an industry insider, "There are no regulations which says that it cannot be done. If the cheque is cleared and the investor is allotted the units, the investor can always ask for redemption."

He said a violation would occur only if the investor was allowed to exit without the cheque being cleared or the units being allocated to him.

Incidentally, apart from a few public sector funds, none of the other fund houses have any limit on the number of entries and exits which can be done in a single day by an investor.

At the moment, market timing is the subject of investigations and intense debate in the US, where the entire mutual fund sector has been shaken up by the scandal, involving some of the biggest names in the business.