The year 2020 was painful for the Indian mutual fund industry. After a surge in flows during the covid-19-driven stock market crash in March, the industry saw sustained net outflows from its equity schemes, a much-watched barometer. The outflows coincided with record number of new demat accounts, expected to touch 10 million in FY21, suggesting that India’s retail investors were dumping mutual funds to try their luck in the stock market.
In addition to regulatory changes, there were market innovations also during these pandemic days.
A. Regulatory changes
The market watchdog- Securities and Exchange Board of India,
brought in a slew of new rules and regulations to make mutual funds more
transparent and investor-friendly, prominent among them are as follows:
1. Change in investment mandate of multi cap funds
In September 2020, Sebi issued a circular changing the
portfolio mandate of multi cap fund schemes. According to the new rule, multi
cap funds will have to invest a minimum of 25 % each in large cap, small cap
and mid cap stocks from January, 2021. This will take the overall equity
exposure of these schemes up to 75% as opposed to the current minimum equity
exposure of 65%, with no market cap limits.
This move aims at making multi cap funds ‘true
to label’ and hold a well-diversified
portfolio. Most multi cap funds had a large cap bias with almost minimum or no
investments in small cap stocks. Many fund houses spoke about converting their
existing multi cap schemes to ESG funds or Focused funds to avoid the new
mandate
2. Introduction of flexicap category
The change in mandate for multi cap schemes did not go down
well with many big fund houses. Many top fund managers and CIOs spoke against
the move and said that this will make the category risky for investors.
The major issue with the change was a mandatory 25% exposure
to small cap stocks. On November 06, Sebi intervened and issued a circular for
the introduction of a new mutual fund category- Flexi Cap Funds. Flexi cap
funds are a new name for the old multi cap funds- a category that is market cap
agnostic and has to have a minimum equity investment of 65%
3. Change in NAV calculation
SEBI also tweaked the rules for NAV calculation in mutual
funds this year. According to the new rules, investors will get the purchase
NAV of the day when investor's money reaches the asset management company
(AMC), irrespective of the size of the investments. This rule comes into effect
from February 1, 2021, and will not be applicable to liquid and overnight funds
4. Tightened inter-scheme transfer norms
In wake of the liquidity crisis triggered by the Covid-19
pandemic, many fund houses were trying to maintain liquidity in some short
duration debt schemes by transferring bad credit to either balanced funds or to
longer duration schemes. Sebi came out with new rules to protect investors'
money from getting impacted by this process
From 1 Jan, 2021, inter-scheme transfer in close-ended funds
can only be done within 3 business days of the allotment of the scheme’s units
to investors and not thereafter. Furthermore, SEBI took cognisance of the
movement of bad credit from one scheme to another and directed that fund houses
shall not be allowed to transfer debt papers to another scheme if there is any
negative market news or rumour about a security in the media or if an alert is
generated about a security for its risk levels.
5. Advisor distributor segregation
SEBIi also mandated
the long-pending segregation of advisors and distributors this year. This was
done primarily to address the issue of mis-selling and overpricing of services
given to retail investors. According to the new rule, a company with both
advisory and distribution arms can either provide financial advice or sell
products to its clients. Individual planners and distributors also have to
choose one of the jobs and register accordingly with AMFI
6. New risk-o-meter label
To help investors make better decisions about
their investments in high risk mutual funds, Sebi introduced a new category on
the risk-o-meter. Apart from the existing five categories of risk, ‘Very high’
risk category will also be seen on the risk-o-meter tool. Sebi also directed
fund houses to disclose and evaluate risk basis the portfolio of the particular
scheme and not the category. From January 1st, 2021, fund houses are required
to make monthly risk-o-meter public along with the portfolio disclosure
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7. Dividend options renamed
Mis-selling in the name of regular dividends is
an old practice in mutual funds. Sebi finally took action to bring more
transparency to the dividend payouts in mutual fund schemes and directed fund
houses to clearly mention that the dividends might be paid from their capital.
Hence, from April, 2021, dividend options in the existing as well as new
schemes will be renamed to clearer, more transparent nomenclature. The dividend
payout option will be renamed as income distribution cum capital withdrawal
option. Dividend reinvestment option will be renamed as re-investment of income
distribution cum withdrawal option and dividend transfer plan will be renamed
as transfer of income distribution cum capital withdrawal plan
8. Norms to bring in more transparency in debt securities transaction
SEBI tweaked the disclosure norms for debt
mutual funds this year to help investors understand the risk levels in the
portfolios early. According to the new norms, fund houses will have to disclose
the yields of the underlying instruments of the scheme, along with the
portfolio on a fortnightly basis.
The portfolio disclosure used to happen on a monthly basis
before the new rule. Fund houses used to disclose only the indicative yield of
the portfolio and not the specific yields of the securities. Mutual fund
advisors say that this move makes debt mutual funds more transparent and credit
risk a little more predictable in these schemes
9. Skin –in-the-game Policy
The phrase
refers to owning the risk by being involved in achieving a particular goal.
Best known as ‘Hammurabi’s code’, it is named after King Hammurabi
(Mesopotamia, 1972-1750 BC), who laid out this set of laws to manage risk.
Three concepts associated with this code are reciprocity, accountability, and
incentives.
Currently, an
AMC has to maintain a networth of Rs 50 crore. Sebi’s panel has proposed
that fund houses be
allowed to make investments in their own schemes from their networth. To ensure
the interests of asset management companies (AMCs)
are more aligned with those of unitholders, SEBI’s board approved scrapping the
Rs 50-lakh cap. Instead fund houses will have to invest, based
on the risk profile of the schemes. The risk profile will be in accordance with
the existing labels under the risk-o-meter framework.
According to a
disclosure bySEBI, AMCs will have to invest 0.03 per cent in schemes with ‘low’
risk profile and 0.13 per cent in schemes with ‘very high’ risk profile, which
are typically equity schemes.
Fund houses
could get up to a year to meet the norms. Certain MF schemes, such as
exchange-traded funds, index funds, overnight funds, and fund of funds, are
exempt from the skin-in-the-game requirement.
The move is
part of a series of steps taken by SEBI to ensure transparency and
responsibility at AMCs.
In April 2020, the
regulator had said 20 per cent of the salary of senior MF executives will have
to be paid in the form of units of schemes they oversee. The above unit based
compensation will have a lock-in period of minimum three years or tenure of the
scheme. If there is any code of conduct violation by the employee, it will be
subject to claw back. These norms were to become applicable from July 1.
Following industry feedback, SEBI has extended the implementation date to
October 1.
B. Industry driven changes
1. Portfolio construction
After witnessing a roller-coaster ride in their
equity investment in 2020, investors are likely to focus on asset allocation
and diversification. This means not only investors would focus on investing in
other asset classes such as debt or gold, they will also look to diversify
their portfolio within a particular asset class. For instance, investors may
opt for a combination of active and passive strategies and invest in funds that
take exposure to international stocks.
The low interest rate regime lead
investors to seek equity investment in 2020. He, however, believes that
investors will protect their downside with asset allocation and diversification
in 2021.
The year 2021 began the trend of acknowledging the passive strategy
in the core portfolio. Investors will invest in a combination of active and
passive funds to grow wealth in 2021.
Another key trend would be exposure to
international stocks through mutual funds. The industry has started offering
products that give investors exposure to international investing. This trend
will gain traction in 2021. The investors will also increase their investments
in real estate and multi asset funds for better diversification which is
already started manifesting..
a). Domestic-global
MF
Although not formally a mutual fund category, this model was
pioneered by PPFAS Mutual Fund in its flagship scheme PPFAS Long Term Equity.
This model invests up to 35% of an equity fund’s assets into foreign stocks,
with the rest in domestic Indian stocks. This allows the scheme to continue to
be taxed as an equity fund under Indian tax law.
PPFAS Long Term Equity saw its assets under management (AUM)
more than double from around ₹2,500 crore at
the end of December 2019 to ₹5,757 crore at
the end of November 2020. Returns of 33.5% (as of 29 December, according to
Value Research data) since the start of the year account for some of this
growth, but robust inflows are the dominant contributor.
Other AMCs have begun to adopt the model. Axis Mutual Fund
adopted it in its Growth Opportunities Fund, ESG Fund and Special Situations
Fund, while DSP Mutual Fund used it in its Value Fund launched in November
seeking value opportunities in India and
abroad.
Some AMCs such as Tata Asset Management have simply amended
the mandates of existing schemes to include global investing. Even SBI Mutual
Fund, India’s largest fund house by assets, has taken a partial exposure to
global stocks in its Focused Equity Fund.
A 65:35 domestic to international equity structure provides a
tax-efficient route to international investing. Diversification is another
advantage.
b). Roll-down
maturity
Debt mutual funds in India have long struggled with the
problem of being unable to explicitly guarantee returns. This turns retail
investors towards fixed deposits and bonds (even risky ones) as they come with
a fixed interest rate.
Roll-down maturity is the industry’s response to this
problem. It involves specifying a target maturity date and holding bonds whose
maturity roughly corresponds with the date in question. This allows the fund’s
return to be predictable if it is held till the target date, although there’s
no explicit guarantee.
The strategy is being seen as a successor to fixed maturity
plans (FMPs) which suffered post the IL&FS debt crisis in 2018. “Roll-down
is an evolution over FMPs which suffered from the limitations of being
closed-end. The discourse around roll-down is also about its structure and
ability to deliver a predictable return rather than tax which was the selling
point of FMPs.
The roll-down structure is used in open-ended funds, allowing
investors to exit at any point of time, unlike the lock-in of FMPs. If the debt
scheme in question is held for more than three years, investors are taxed at
20% on capital gains and given the benefit of indexation, giving them an
advantage over FDs. Further, if the bonds held by the roll-down scheme are high
quality, there is more certainty on returns.
The concept was popularized by the Bharat Bond ETFs (Exchange
Traded Funds) which were launched in December 2019 and again in fresh tranches
in mid-2020 and has been adopted widely across the industry.
c.) ESG
Investing
ESG or Environmental, Social and Global Investing is an idea
that caught on in 2020. ESG philosophy seeks to weed out companies which fail
to satisfy specified norms on corporate governance, environmental impact or
social awareness. Until 2019, there were only a couple of ESG schemes, but in
2020, most of India’s large AMCs, including Aditya Birla Sun Life, Axis, Mirae,
Kotak and ICICI Prudential, launched such schemes.
The jury is out on whether the trend is more than a marketing
gimmick, but experts largely favour it.
SEBI’s relaxed norms on who can foray into
MF business can attract many fintech players. Until now, the regulator required
entrants to demonstrate three years of profitability and maintain a net worth
of Rs 50 crore. However, SEBI has now done away with the profitability norms.
Now, companies will be eligible to sponsor a mutual fund if they have a net
worth of Rs 100 crore.
These relaxed norms will attract many
fintech players to start their mutual fund business. Now that it is not
mandatory to show 3 years of profitability, many fintechs can enter the MF
industry. The entry of new players could also lead to mergers and acquisitions.
Fintech firms, which provide and rebalance model stock
portfolios at low cost, tied up with brokerages, disrupting the very USP of the
industry. However, within all the gloom and doom, a few new models have taken
root and may yet rescue mutual funds in 2021.
This is interesting to have watched: From solitary UTI to bank sponsored, FI sponsored, Brokerage sponsored to Fintech sponsored MFs have tweaked the expenses of investing in equity market bringing down the distribution expenses, transaction expenses, increasing ease of doing business and overall decreasing dealing time with seamless opportunities.
3. Wider participation using technology
With more new players and use of
technology, the year 2021 witnesses increased participation from the remote
areas of India and young investors.
The industry has swiftly moved to digitaltransactions and virtual communication in 2020. This will pave the way for MF
industry to reach out more investors in the hinterland in 2021.
The MF industry will penetrate deeper into
smaller cities with the message of consistent investing via SIPs. Delivering
the message in the local idiom and more intensive coverage through feet on the
ground will be the key to increase penetration in B30 cities. Further, the
industry will focus on improving digital efficiency to attract millennials.
