Filling a gap

New asset class for mutual funds will help HNIs

The Securities and Exchange Board of India (Sebi) has proposed an asset class for mutual-fund (MF) investors. A consultation paper in this regard was published on July 16 and public comments will be accepted on the proposed scheme until August 6. This new asset class would allow asset management companies (AMCs) to launch funds packaging high-risk, high-return trading strategies to investors with the risk appetite and financial capacity. The proposal places these products halfway between portfolio management schemes (PMS) and “vanilla” mutual funds (MFs). The minimum investment value is Rs 10 lakh, which is less than the minimum Rs 50 lakh threshold for PMS. AMCs launching these schemes would have to appoint chief investment officers with at least 10 years’ experience in managing assets worth at least Rs 5,000 crore, and additional fund managers with at least seven years’ experience handling at least Rs 3,000 crore. The AMC itself must have been in operation for at least three years with assets of at least Rs 10,000 crore.
 

While these proposed MFs would provide the options of systematic investment plans (SIPs), systematic withdrawal plans, and systematic transfer plans like any MF, the fund managers of the new asset class would have the flexibility to use strategies involving derivatives for purposes other than hedging. Funds in the new asset class would need to be branded differently to ensure that investors distinguish between these and low-risk vanilla MFs. These funds would also have more flexibility in tailoring redemption frequency to ensure the managers do not face sudden liquidity constraints. The paper also suggests that units be listed on stock exchanges (as with exchange-traded funds, or ETFs) to allow for easy entries and exits.
 

The paper suggests this new class of funds build “Long-Short” portfolios to exploit rising as well as falling share prices, and also they may craft “Inverse ETFs” models designed to move the fund’s portfolio in the opposite direction to a benchmark ETF. Such strategies would allow the fund to exploit price movements in either direction by using derivatives. These are typically strategies deployed by hedge funds which can generate high positive returns, no matter what the market direction may be. However, they are also high-risk and require careful management since they can blow up with very high losses. One of the objectives of the proposal is to allow investors with the requisite resources and risk appetite to participate in high-risk strategies without resorting to unregistered, unauthorised entities.
 

In the absence of such a formalised asset class, investors with a corpus in this range have been known to enter schemes floated by unknown entities that promise unrealistically high returns. By providing a regulated environment, Sebi hopes it can push such unauthorised schemes out of the market and replace them with regulated funds. Formalising this new asset class is tacit acceptance of the needs of investors with this profile, and it offers them a modicum of protection against unregistered traders. However, if this new asset class takes off, Sebi and the exchanges will have to deal with a surge in volumes of derivatives, and tighten the surveillance and margin systems appropriately. Assuming that occurs, this new asset class fills a gap in the market.