Now, fund houses can't restrict redemptions

Experts say Sebi's new rules to make MFs safer for retail investors but many fund houses disagree

To protect small investors from tricky choices made by mutual fund managers, the market regulator Securities and Exchange Board of India (Sebi) has introduced new redemption rules. Now, mutual fund houses cannot restrict redemptions unless there’s a crisis that can affect the industry at large. Even in such cases, investors will be able to withdraw up to Rs 2 lakh.

The new rules have been introduced after the crisis in JP Morgan Asset Management. The fund house’s two schemes had a combined exposure of Rs 193 crore to Amtek Auto’s papers, which were downgraded sharply by the rating agencies due to the company’s deteriorating financials. To deter panic redemption, the fund house imposed a daily redemption limit of one per cent (of investment value) for the schemes.

Experts say the new provisions work in favour of investors and will make mutual fund houses introduce better liquidity management tools. “Mutual funds will introduce processes to avoid one off situations like we witnessed in the JP Morgan Asset Management’s case. It’s not always that fund houses need to sell the securities in their portfolio to meet redemption demand. They also have alternatives, such as borrowing, in such cases,” says Vidya Bala, head of mutual fund research at FundsIndia.com.

 

Crisis happens when fund managers chase yields and invest in lower-rated papers. After JP Morgan Asset Management crisis, Sebi came down heavily on the industry and has introduced new rules even on the exposure a scheme can have to a company or conglomerate. “All this has resulted in funds sticking to high quality papers and maintaining average maturity of the portfolio according to the nature of the scheme,” says Bala.

Experts say the redemption pressure is usually created by institutional investors. Retail investors typically wait it out as they don’t prefer to exit at a loss. “In times of crisis, often institutional players arm-twist fund houses to relax norms for them. New rules will not allow such disparity,” says Manoj Nagpal, CEO, Outlook Asia Capital, a consulting and wealth management firm. According to him, the quality of papers was deteriorating and the proportion of papers rated AA and A was increasing. “Fund manager will now need to keep high quality papers in the portfolio that can be liquidated easily,” says Nagpal.

Just investing in quality papers is not enough. “Fund houses will now have proper research teams for debt papers to understand the company. They will also need to regularly keep evaluating the company after investing in it,” says Jimmy Patel, CEO of Quantum Asset Management.

He says buying quality papers today, which see downgrades in ratings later on, cannot be an excuse. “Before a company’s rating is downgraded, there are ample indications that can tell a fund manager of its deteriorating financials. They don’t need to rely entirely on rating agencies,” says Patel.

But, some mutual fund houses are unhappy and say that the new rules can go against existing investors in certain cases. “Globally, mutual funds have gate provision, whereby fund manager can restrict withdrawals during a redemption period. In case of high redemptions (called a run on the fund), the fund manager will need to sell his liquid securities to meet the requests, crippling the operations. This will result in the value of portfolio falling sharply. Those who remain in the scheme would be stuck with illiquid papers and low returns,” says CEO of a mutual fund.

In its circular, Sebi has also said that if there are restrictions imposed in case of crisis that can affect the functioning of the entire industry, investors should be allowed to withdraw up to Rs 2 lakh. Financial planners believe that this provision can lead to investors making mistakes. “Say, there’s a situation like 2008 when stock markets witnessed sudden large corrections due to global financial crisis. It’s best for investors to wait out rather than redeem in panic at a loss,” says Hemant Rustagi, CEO of Wiseinvest Advisors.