Sebi should revisit liability side of MFs

This would be a good time to change the 20-25 rule to 50-5 or 50-10

Mutual funds (MFs) are very competitive anima­ls. So, if I don’t lend to a new company and keep money in overnight instruments, I earn 6.25 per cent. If I lend to a non-banking financial company, I earn 8.50 per cent. The over 200 basis point (bps) difference between overnight and three-month commercial paper is significant…,” Santosh Kamath, managing director and chief investment officer, Franklin Templeton (FT) Mu­tual Fund told a television channel 18 months back.

The 200 bps extra return has come back to bite the fund house. Last Thu­rsday, it shut down six schemes with assets of around Rs 26,000 crore, and that too, after accounting for significant borrowings to meet the redemption pressure. This is the first time that one of top 10 fund houses has had to take such a severe step.

The question: Notwithstanding Ka­math’s grandstanding in the television interview, should the blame be entirely on the fund house or the fund manager? Obviously, no. Investors should ha­ve done their due diligence, and no one should complain as far as the credit-risk fund goes because the scheme was expected to… well... take credit risk. But the other debt funds — ultra short-term, short-term, low-duration and others — didn’t give any impression of having risky papers. At least, the na­mes didn’t reveal any such design.

Franklin Templeton’s debt funds have been known to follow the high risk-high return formula for a while now. In 2015, four of its schemes — Franklin India Low Du­ration Fund, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund, and Franklin India Income Opportunities Fund — lost over 20 per cent of their debt assets in a single month after the Amtek Auto fiasco. They are part of the six schemes being shut down.

That’s not all. In 2016, when Jindal Steel and Power’s (JSPL’s) non-convertible debentures (NCDs) were downgraded to the D (default) category, the asset management company bailed out the schemes by buying the debentures at a 27 per cent discount. More recently, the write-down of Voda-Idea bonds and Yes Bank AT1 bonds in January and March (where it side-pocketed the bonds) were clear signals that things weren’t going as planned. But, the lure of higher returns kept investors interested till the debacle.

The “mutual frustration” — both among fund houses and investors — is due to the fund managers’ desire to garner assets under management coupled with investors’ demand for hi­gher-paying schemes in debt funds. The fixed maturity plan debacle of 2008 immediately comes to mind. Fund managers took excessive exposure in papers of the realty sector to boost returns, and when investors rushed to redeem, a special window had to be opened by the Reserve Bank of India.

However, what is interesting about these special windows is that few borrow from them actually.

They are lau­nched only to give investors the assurance that fund houses have access to liquidity. Currently, the Securities and Exchange Board of India (Sebi) has allowed schemes (on a case-by-case basis) to borrow as much as 30 per cent of their assets, but like the Franklin Templeton case shows, it is not a viable model. The fund house borrowed arou­nd Rs 4,000 crore to redeem initially, but had to shut down ultimately.

Sebi comes out with stricter guidelines after every such event. This time, too, it may do so. But the regulator’s approach has always been to tackle the problem from the asset side, such as putting sectoral or company level caps. It’s time to look at the liability side as well, especially for debt mutual funds. For example, under the 20-25 guideline, a scheme needs to have minimum of 20 investors and a single investor can have a maximum of 25 per cent exposure (on a quarterly basis). This needs a revisit. Say, a Rs 10,000-crore scheme has 20 investors, but two big investors have put in Rs 2,000 crore each. Even if one big investor decides to pull out, the fund house will have to scurry to raise funds.

If this rule is changed to say, 50-5 or 50-10 — minimum 50 investors and maximum 5-10 per cent — things wou­ld become easier. Importantly, one big redemption will not bring down an entire scheme. Yes, it does mean more work for fund houses, but there will be fewer sleepless nights. Similarly, the ranking of fund houses should not be based only on assets under management. Qualitative parameters like re­tail-corporate mix, geographical reach, asset quality and others should also be used.

The private sector mutual fund industry has been around for over two decades, but it has gone through multiple shocks. Despite all the good work like giving 15-20 per cent annual re­turns in their equity schemes over long periods, every such incident hits its reputation badly. It’s true that fund managers can’t control stock markets, but it’s time they stopped succumbing to investors’ greed and race to garner assets under management.