Shift your investments if Sebi pulls up AMC for regularly flouting norms

Market regulator Securities and Exchange Board of India (Sebi) wrote a letter to the Association of Mutual Funds in India (Amfi) on July 9 warning its members regarding 25 violations it had observed during inspections of fund houses carried out between April 2014 and March 2016. In its July 25 meeting with independent trustees of mutual funds, the regulator brought up the issue of these violations again and asked trustees to ensure high standards of corporate governance. Clearly, all is not right with the Rs23.57 trillion industry, despite investors, especially retail, reposing their trust in it and enhancing its assets under management (AUM) in a big way in recent times.  

Industry insiders say that investors should not get excessively perturbed. Says A Balasubramanian, chairman, Amfi and chief executive officer (CEO), Birla Sun Life Asset Management: “Amfi has forwarded Sebi’s observation to all the members to ensure that fund houses are aware of these issues and take care of them.” Adds Jimmy Patel, CEO, Quantum Mutual Fund: “If these violations were significant, Sebi would have taken action against fund houses. But the letter should not be taken lightly either. It’s more like an advisory so that such issues do not arise in future.” Let us turn to some of the key violations that could affect your investments. 

Deviation from mandate: Sebi’s letter flags the risk of schemes deviating from their objectives, as mentioned in the scheme information document (SID). Investors choose a fund because its mandate suits their financial objective and risk profile. “If a fund deviates from its mandate, it puts the investor’s financial goal at risk or subjects him to higher risk than he desired,” says Vidya Bala, head of research, Fundsindia.com. Funds should avoid such deviations both in letter and spirit. She cites the example of a short-duration fund. While there are rules on the duration of bonds they can hold, there are no rules on how much credit risk such funds can take. If such a fund takes high credit risk and a default occurs, it would subject investors to a risk they had not bargained for. Investors need to select funds that have a reputation for sticking to their mandates across market cycles.

 

Concentration risk: Sebi’s letter also warns of instances of blanket approval being taken from the AMC and trustee board for increasing the investment limit in the debt instrument of a single issuer. After the default of Amtek Auto bonds that had hit JP Morgan’s funds, Sebi had tightened exposure norms. The maximum that a fund can invest in a single issuer’s bonds is 10 per cent (extendable to 12 per cent with trustee approval). Exposure to a single corporate group was capped at 20 per cent (extendable to 25 per cent), and sector limit was capped at 25 per cent. If a fund violates these norms, and a default occurs, investors will be hit much harder than if the fund stays within them.  

Trustees’ permission not taken for dividend distribution: Sebi’s inspection revealed instances where trustees’ approval was not taken for dividend distribution, or the power of trustees to declare a dividend, decide on its quantum, and fix the record date was delegated to AMC officials. There have been concerns in the recent past about balanced (aggressive hybrid) funds being mis-sold with the promise of regular dividends. “Fund houses may have declared special dividends to pay off investors as promised without taking the approval of trustees. But if the board and the trustees are to be held responsible for the actions of the asset manager, then their approval must be taken,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.  

Mark-to-market risk in closed-end funds: Another issue flagged is that of closed-end funds investing in instruments of maturity beyond that of the fund. When a closed-end fund like a fixed maturity plan (FMP) invests in bonds whose tenure do not match that of the fund, the latter gets subjected to mark-to-market risk. 

Since the corporate bond market is not very liquid, there is a demand-supply issue due to which bonds of the same maturity are sometimes not available. Belapurkar says that if there is a small mismatch, say, of 15-30 days, it is not a cause for concern. If an instrument has a few days left for maturity when the fund matures, it can be taken up by another fund of the same fund house. “The pricing of the bond in such a transaction should be fair,” says Belapurkar. He adds that if the gap between the maturity date of the fund and that of bonds is more than 30 days, then it is a cause for concern. 

Investor beware: Sebi’s letter highlights the need for investors to select funds based not just on their performance track record but also their reputation for sticking to high standards of corporate governance. Investors should keep an eye on the formal orders issued by Sebi. If a fund house is pulled up repeatedly, there may be an issue with its corporate governance. Patel suggests that investors should also keep abreast of the disclosures made in the monthly and annual reports of fund houses.  

Finally, if your fund house gives much higher returns than its peers, be warned. While this may be due to the fund manager’s investment prowess, there is also a possibility of the fund taking a concentrated risk in particular securities or sectors, or deviating from its strategy. Consult your advisor regarding whether you should exit the fund.