AMFI Members Summit
August 27, 2019; Mumbai
1. Ladies and Gentlemen, it gives me great pleasure to be here today and to present my thoughts and perspectives on the Mutual Fund industry. I thank AMFI for inviting me to this Summit.
2. I had the privilege of being present here last year where I shared my thoughts on the subject. I would try to build upon it and touch upon the events and initiatives that have transpired since then.
A. Background:
3. As a capital market regulator, one of our objectives is to promote the growth of the securities market through greater investor participation. Mutual Funds are one of the most important institutions through which money collected from various investors, especially retail investors are channelized into the capital market. The importance of Mutual Funds can be seen through the sheer size of the AUM of the industry which stands at more than INR 24.5 lakh crores today. Therefore, promoting the growth of the MF industry while protecting the interest of its investors has been and will always be one of the important focus areas of SEBI.
4. The growth in the mutual fund industry in the last few years has been significant. Comparing AUMs as on March 2015 vis-à-vis July 2019, the AUM of the entire industry has more than doubled from around INR 10 lakh crores to the present level in just four years. The AUM of equity schemes during the same period has increased from around INR 3.5 lakh crores to INR 7 lakh crores and that of non-equity schemes has increased more than 2.4 times from around INR 7 lakh crores to INR 17 lakh crores.
5. During the same four year period, the number of MF folios have also more than doubled from around 4 crore to around 8.5 crore. The increase is largely due to increase in equity folios wherein retail investors are major participants.
6. I must compliment all of you for the role played towards the growth of the industry. This has also led to Mutual Fund being the preferred mode of Investment and helping in financialization of saving. To take the industry to next level of growth and development, it is important to have better self-regulation and risk management.
7. However, I would like to reiterate what I had said in the last AMFI conference that the total industry AUM accounts for only around 11% of the GDP. Corresponding figure in the US is around 100% and the global average is close to 60%. We definitely have a long way to go.
B. Recent initiatives by SEBI:
8. In the last one year, SEBI has taken multiple initiatives with respect to various aspects of the Mutual Fund industry.
9. A substantial part of the initiatives taken by SEBI is related to debt funds. Since I would be talking about that separately, let me elaborate on some other initiatives which SEBI has taken recently.
10. Improving transparency and disclosures to the investors enable better investment decisions and protection of investor interest. Towards this end, several initiatives have been taken by SEBI including daily disclosure of TER of all schemes on the websites of AMC and AMFI, disclosure of TER break-up in the half yearly consolidated statement, disclosure of performance of all schemes of all Mutual Funds on AMFI website to be uploaded on a daily basis, standardization of performance disclosure post consolidation/ merger of schemes, etc.
11. Another objective behind many of our recent initiatives has been to rationalize the existing requirements and provide clarity where required. With this objective, last year SEBI notified several norms including on charging of expenses only to the scheme, adopting a full trail commission model, clarity on expenses under direct plans, additional TER based on B30 inflows from retail investors for incentivizing penetration, clarity on definition of equity oriented scheme for calculation of TER, etc.
12. While the AUM of the Mutual Fund industry has grown multiple times over the years, the slab wise limits of TER introduced in 1996 have not been modified or changed since then. Upon taking into consideration the inflation and with a view to passing on the benefit of economies of scale to investors, the slabs have been suitably revised after consulting various stakeholders.
C. Issues and challenges:
13. Despite all the recent measures taken, many issues and challenges still remain. Let me elaborate some of these.
Credit defaults and debt mutual funds
14. Last year saw several credit defaults by some entities having an adverse impact across the financial sector in India. These defaults led to a cascading effect with significant redemption pressures in debt mutual fund schemes, more so in liquid schemes. Within just 2 months i.e. September and October 2018, the AUM of all debt oriented schemes as a whole fell by 18% and that of money market schemes fell even more, by 25%. This was despite the fact that the total exposure of all mutual funds schemes to the stressed securities was only around 1% of the total AUM of all debt oriented schemes.
15. Such an impact was not just restricted to a few mutual fund schemes but led to a general erosion of trust of investors in debt schemes. Meanwhile, during the turmoil, concerns were also raised with regard to mutual fund exposure in debt and money market instruments having structured obligations or credit enhancements in various forms and complex structures.
16. SEBI undertook a review of the risk management framework of debt funds, especially liquid funds, and prudential norms governing investments in debt and money market instruments. The efforts focused on ensuring that the systemic risks arising from such events are as minimal as possible. The measures included permitting the creation of segregated portfolios subject to certain conditions, reduction in cap of overall sectoral limits, minimum holding of 20% in liquid instruments by liquid schemes, restrictions on investments in debt instruments with structured obligations and credit enhancements, dispensing of valuation of debt and money market instruments based on amortization, provision for graded exit load in liquid schemes, restriction on investments in unlisted equities, NCDs and CPs, etc.
17. SEBI also reviewed the existing valuation provisions to make them more reflective of the realizable value, to bring in uniformity and consistency in approach, increase robustness of the process and address possible loopholes and misuse of the provisions. Based on the review, it has been decided to take certain measures including those relating to the waterfall approach for valuation of non-traded money market and debt securities, flexibility for valuation agencies to ensure fair pricing of securities while continuing to have the final responsibility on the AMC for fair valuation, norms relating to valuation of Inter-scheme Transfers, disallowing the use of own trades for valuation, etc.
Way forward
18. Till about a year back, the significant growth of the mutual fund industry was one of the most talked about success stories of capital markets in India. The events in the last year, however, exposed the fault lines in the industry and showed that a credit event in even one issuer/group could have a contagion effect leading to liquidity risk across the market.
19. The figures speak for themselves. While it has been around a year since the defaults started, the AUM of open ended debt schemes is yet to reach the AUM levels seen at the end of August 2018. Such instances do not reflect well on the industry practices. While SEBI stepped in and took several measures in the interest of the investors, the need for us to step in may not have arisen if many of these measures were taken by the industry itself.
20. To give an example, based on our study of liquid schemes, it was observed that in 20% of the instances, the average holding in liquid instruments was less than 5% of AUM as compared to an average net redemption in these schemes of around 19%. A certain element of self-discipline by the industry could have averted such a situation.
21. The recent events also threw into the spotlight several risky investments made by the industry in the quest for higher yields. The safety of the investment cannot be compromised for want of higher yields. While we have taken steps to restrict such investments, the industry as a whole needs to do its own analysis on a regular basis to avoid such situations in future.
22. I will also like to re-emphasize on something I have said earlier. There is a clear distinction between lending and investing. A mutual fund’s investment strategy needs to have required elements of safety as well as returns. While making an investment, the mutual funds have to necessarily take into account their mandate and organizational structure. Mutual Funds do not have risk capital and are essentially pass through vehicles wherein NAV ought to reflect the correct value of assets held at any time. This is an important aspect which Mutual Funds should keep in mind while making debt investments.
23. SEBI’s primary objective is the protection of investor’s interest, based on which we have issued appropriate regulations and circulars from time to time. These regulations and circulars have been drafted with wide consultation with all stakeholders and due analysis. Needless to say that the industry needs to adhere to them and play as per the rule book.
Role of trustees
24. Another area which I would like to focus on is the role of trustees in the mutual fund industry. While my colleagues would cover the more technical aspects in today’s session in the second half, I would like to give my broad views on the subject.
25. The role of Trustees is pivotal in the Mutual Fund ecosystem. The designing of the trio Mutual Fund structure with the fund-AMC-trustee as its constituents was a conscious call on SEBI’s part wherein the fund was to be the pooling structure, AMC was to handle the management and operations of the fund and the trustee was to act as an overseeing authority on an independent basis as a fiduciary of the MF investors. The Mutual Fund Regulations cast enormous responsibility upon the Trustees. One particular regulation I would like to highlight is Regulation 18 (10) of these Regulations which states that where the trustees have reason to believe that the conduct of business of the Mutual Fund is not in accordance with the regulations and the schemes, they shall forthwith take such remedial steps as are necessary and immediately inform SEBI of the violation and action taken by them.
26. From the inspections conducted by us sometime back, several issues came to SEBI’s notice. While some of the issues are case specific in nature, certain issues are quite prevalent in the industry as a whole. In this scenario, trustees are not expected to be passive participants in the MF ecosystem. Where there are concerns and lapses, we expect the trustees to step up their efforts as the first level gatekeepers, take remedial steps and immediately make necessary intimations to SEBI and not wait for SEBI to step in and take corrective measures.
27. Going forward, I hope to see greater proactivity on the part of Trustees where there are such concerns and lapses. However, a balance is required so that it does not hinder the day-to-day operations and fund management activities.
Investor outreach
28. An important challenge that continues to exist is to expand the investor outreach. In my last year’s address, I had observed that while the B-15 AUM as a percentage of the overall AUM has climbed up from 12.7% in 2012-13 to 17.7% in 2017-18, the time is now ripe for the industry to concentrate on B-30 centres. Towards this end, SEBI has already revised its norms permitting 30 bps additional TER for B-30, instead of B-15, and also clarified that since the objective is to attract more retail investors from these areas, the additional TER would only be permitted based on B-30 inflows from retail investors. As on date, the B-30 AUM stands at around 16.2% of the total industry AUM. I do hope to see a further increase in this geographical reach in coming times.
29. Apart from the geographical reach, an important focus area is to expand the types of investors in the industry. It is encouraging to see increasing number of millennial and women investors in mutual funds. However, there is a large space that remains untapped. Women constitute around half of our population and youth around 35%. Such investors may have different reasons to get attracted to mutual fund investments. Other factors such as education, regional differences, marital status and children, etc. also significantly influence investment decisions in different ways. Therefore, while increasing investor awareness, targeted programmes for different types of investors may be a good way to attract such specific investors into the mutual funds space.
Ease of doing investment in Mutual Funds
30. If we want more investors to be attracted to investments in Mutual Funds, the process of entry, exit and management of investments ought to be simple and easy. Recently, the Finance Minister announced that in order to improve market access for the domestic retail investors, Aadhar-based KYC is to be permitted for opening of demat account and making investment in mutual funds. We will work with the Government on this with a view to operationalizing the decision.
31. To further ease the process of investing in mutual funds, a working group had been formed some time back by SEBI with multiple stakeholders. The group has since submitted the report and we are in a process of implementing its recommendations.
Direct plans and ETFs:
32. When I addressed this summit last year, I had spoken about the need to promote direct plans. There are two important benefits attached to a direct plan- first, the financial benefits in terms of lower TER to the investors by directly investing in the scheme; the second being the overall idea of using technology for ease of doing transactions.
33. We have observed during our inspections of Mutual Funds that the difference in the TER between direct and regular plans is not exactly to the extent of distribution expenses and commission paid. Such practices are not desirable and defeat the very purpose of direct plans. We have recently specified that all fees and expenses charged in a direct plan in percentage terms under various heads including the investment and advisory fee shall not exceed the fees and expenses charged under such heads in a regular plan. This is expected to ensure that the difference in expense ratios between the two plans is not misused for charging additional expenses under other heads.
34. Despite all the measures taken till date by both SEBI and the industry, the numbers I am seeing with respect to direct plans are not very encouraging.
35. On a related point, last year I had highlighted that ETFs are another set of products that are yet to catch the fancy of Indian investors. They account for only around 6% of the total MF AUM in India as compared to their massive takeoff globally. ETF, as a product, offers the advantage of having a lower TER than other fund offerings. Not much progress has been made in encouraging investments in ETFs.
36. In both these areas, namely direct plans and ETFs, a combination of investor awareness programmes and use of technology can play an important role.
Technology and digital platforms
37. Technology can be an important tool to address various issues and improving efficiency of the mutual fund industry i.e. improving investor outreach, ease of investment, more efficient fund management, customer servicing, meeting disclosure requirements, launch of new products, etc.
38. We have recently set up a working group for overall development of digital platforms to enhance MF penetration and addressing the related issues. The working group is deliberating various aspects and is expected to submit its report shortly.
39. While technology can play a positive role, we cannot ignore the challenges that also come along with technology. One such challenge pertains to cyber-crimes. Some of the cyber-crimes witnessed in the financial world in recent past have been quite alarming. With rapid technological advancement in securities market, there is a greater need for maintaining robust cyber security and to have cyber resilience framework to protect integrity of data. SEBI has issued guidelines on this subject which I will request you to adhere to not only in principle but also in spirit.
Stewardship role:
40. Mutual funds are large investors in the capital markets. While investing as institutional investors in a company, they have a fiduciary responsibility towards thousands of investors who have put in their money in the fund. Therefore, the stewardship role of mutual funds becomes extremely important. Ever since SEBI introduced the disclosure of voting policy and voting decisions, we have seen an increase in participation of mutual funds in voting on shareholder resolutions.
41. Last few years have seen corporate governance lapses in some listed companies. Wherever the mutual funds are sizable investors in such companies, they can play an important role in improving governance by fulfilling their stewardship obligations.
D. Concluding remarks:
42. The tagline often associated with Mutual funds is “Mutual Funds Sahi Hai”. The investors, especially the retail investors investing through SIPs, repose a lot of faith and trust in Mutual Funds. We ought to remember that it takes years to build trust in an industry and only a single event may erode it. So there should be a collective effort by all stakeholders including AMCs, trustees and SEBI to uphold and maintain that trust and faith.
43. We in SEBI are open to new ideas and suggestions to take the mutual fund industry to the next level. We endeavor to adopt consultative approach prior to taking major policy decisions. We look forward to your suggestions on various aspects to bring in further improvements in the regulatory framework.
Thank you and all the very best!
