The Meek Won't Inherit

 Of course, mutual funds, and more importantly asset management companies (AMCs, or companies which actually manage the mutual funds' investments), welcome many of the recommendations. No one, for instance, has a quarrel with the fact that the six-member committee has recommended a standard Net Asset Value (NAV or the current value of the mutual funds' investments) calculation method for all mutual funds. So also for the recommendations on adequate disclosures. Indeed, some feel that even more stringent norms could have been attempted. "In the final analysis, the best protection to the investor is by ensuring adequate disclosures. They should have provided for a high penalty if disclosures are not adequate," says Advani. SEBI's Executive Director Pratip Kar, who headed the committee, could not be contacted since he was away on holiday. The committee has recommended that AMCs announce NAVs on a weekly basis. The more progressive funds would not mind even daily disclosures.

The recommendations regarding disclosing brokerage and custodial and other payments to any entity which is a major shareholder in the AMC has also been welcomed. Though, say critics, the report is silent on a fund's investment in entities where a major shareho-lder of the AMC has a substantial stake. In the absence of regulations, an unscrupulous promoter has the opportunity to use the AMCs' funds (which, significantly, is other people's money, usually the small investors') to shore up the share prices of his other companies.

The committee should have insisted that a full list of investments, as outstanding on the reporting date, be made available to all investors, instead of just filing with SEBI, says a top investment banker. While this may lead to increased expenses, it would ensure that the information is available easily to the investor. This reporting should also make special reference to investments whose value has depreciated by more than 20 per cent of its acquisition price, and explain why the fund manager thought it to be a wise investment decision. Says a big investor: "An investor has the right to know why an AMC bought a share for Rs 400 which is locked in for five years when the market price of that share six months later tumbled to Rs 175."

 Clearly, the industry agrees that mutual funds and AMCs need to be far more accountable. But the one recommendation that has the funds up in arms is the suggestion on the AMC's fees. Outlook has gained access to a confidential letter to D.R. Mehta, chairman, SEBI, from the Chairman of the Association of Mutual Funds in India (AMFI), G.A. Shenai. The letter reads: "In an era of economic reform and free competition, while we welcome greater regulation on disclosure and standardisation, price control from a centralised agency goes against the international practice adopted by the mutual funds industry. For example, in the US and the UK, there is extensive regulation of mutual funds but no intervention in fees and remuneration." Shenai refused to discuss his grievances even when he was told that Outlook had a copy of his letter.

AMCs charge a fee for managing the mutual funds' corpus and for their running expenses. This fee is paid out of the money the AMCs manage. Presently, AMCs are allowed to charge up to 1.25 per cent of the weekly net assets outstanding for assets not exceeding Rs 100 crore and 1 per cent of the excess amount over Rs 100 crore. The committee has recommended this fee to be split into a basic fee and an additional fee which will be linked with the performance of a fund. For the first Rs 100 crore, the basic annual fee would be 0.8 per cent, and then progressively lower for larger corpuses.

The additional fee will be calculated as a percentage of net growth and is subject to a ceiling of 0.5 per cent of average weekly NAV and 1.25 per cent of the netgrowth. The committee has defined net growth as the amount by which the scheme’srealised and unrealised investment gains and other income exceed the realised andunrealised investment losses and expenses. In the event of a decrease in NAV for the year,the decrease has to be carried forward to next year and deducted from the NAV of that yearfor calculating the additional fee.

These recommendations are a response to the growing perception in the market that,while investors are losing money after having invested in mutual funds (NAVs of mostmutual fund schemes launched in the last two years are less than the amount investors putin), the AMCs have been making money by charging fat fees. But, says Advani: "Thecommittee has gone beyond their brief and has started micro - managing the assetmanagement companies." A point that Shenai’s letter also makes.

Sanjay Jha, vice-president, Alliance Capital India, sees a lack of real-world logic behind the recommendations. Segregating the management fee into two components will make AMCs extremely vulnerable in typically bearish markets like the current one, he feels. "Even the supposedly best fund manager is going to find it difficult to post a positive growth," he says. He also contends that if the committee is penalising the AMC for low growth in NAV, it should also provide incentives—in the form of higher fees—if the AMC manages a higher growth rate by the same logic.

SENIOR AMC managers agree that when a market goes up by 20 per cent and the NAV goes up by only 5per cent or less, the AMC should be hauled up for bad performance. But the AMC could actually outperform the market index and still show a negative growth! Shenai wrote in his letter to SEBI: "In a bear market, where the benchmark index may have fallen, say 23 per cent, but the NAV of the fund has fallen only 15 per cent thereby indicating better performance of the fund, no additional fee is payable as the fund has not performed by way of net growth." And there is a still stranger aspect to the recommended fees ( see box ).

What the entire industry is unanimous about is that reduced fees would translate into reduced costs by the AMCs which may affect service to the investors. Says Janak Talsania of Kotak Mahindra Finance: "The repercussions of the recommendations may turn out to be pretty serious. The only redeeming fact is that the committee has only made its recommendations. They haven't yet been applied."

There are some broader questions too raised by the committee's AMC fee advice. Says Advani: "Apart from the percentages and other such details, the problem with the recommendations is more fundamental. It is trying to find artificial solutions to a problem which is market-related." A mutual fund share is after all a risk instrument, and the NAV of an average mutual fund will reflect the general situation prevailing in the share market. By squeezing the AMCs, the committee is attempting some extra damage control for the small investor who put his money in the mutual fund. But, in a liberalised scenario, shouldn't the quantum of fees charged by the AMC be for the market to decide? Shouldn't SEBI limit itself to ensuring that every penny spent, every penny invested and every penny earned by the AMC is properly accounted for and disclosed to the investor?

And if these recommendations become regulations in toto, will they not discourage new entrants, especially the smaller ones, into the mutual funds business? With the limping track record of mutual funds haemorrhaging deeper and deeper in the present market conditions, the committee's recommendations may well be the death-knell of several funds being planned in the near future.