Market regulator, the Securities and Exchange Board of India’s (Sebi) circular declaring mis-selling of mutual funds (MFs) as a fraudulent and unfair trade practices is a welcome step. There are quite a few horror stories of MF distributors who sold as many as 100-150 schemes to a single investor, all to earn entry loads and trail commissions.
But experts say the circular may achieve little on the ground. Often mis-selling is not so obvious. For instance, your distributor may convince you to invest in a new fund offer (NFO) saying it is cheaper. So, with Rs 1,000, you can buy only 10 units of the existing scheme, while you can buy 100 units of the NFO at Rs 10 per unit. Now, assuming both schemes grow by 10 per cent in a year, the NFO's net asset value (NAV) will become Rs 11, while the existing scheme's NAV will become Rs 110. So, if you invest Rs 1,000 in both cases the growth is Rs 1,100.
Churning of MF schemes, that is, pulling money out of one scheme and putting it into another is another very common form of mis-selling. The distributor makes money every time the investor redeems and invests money.
Experts also say churning is seen more in MFs sold by banks. The product head of a leading fund house says that investments that come through independent financial advisors are typically longer term than those led by a bank. But the fact remains that banks continue to be the largest distribution channel for most fund houses.
Some other forms of mis-selling are when a risk-averse investor is sold an equity fund, which by its very nature of investment, is risky. Or an investor who has money for six months or one year is advised to put money in equities. Ideally, one should look at equity funds only for long term investment, again due to the volatile nature of the asset.
“The fund should match the risk profile and time horizon of the investor. Often distributors only focus about the potential risks, but not the risks. Sebi’s rule will work only if we follow a process where it is put down in writing what is the risk profile and the objective of the investor,” says a certified financial planner (CFP).
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Will having a free-look period like that offered for insurance products help? Maybe not, since MFs’ returns are calculated on a daily NAV basis. But even in case of insurance, the utility of the free-look period is doubtful, the CFP says. “Why do investors realise that the product is not suitable for them after they buy it?”
As an industry expert says, Sebi’s circular is much like the insider trading guidelines. Though the rules are tough, it’s very difficult to prove. At the end of the day, an educated investor is better placed to detect fraud. The industry should focus on investor education.