The Securities and Exchange Board of India (SEBI) has safeguarded investors’ interest by making mutual fund houses more accountable. Guidelines governing the industry are strict, clear, and one of the best in the global context.
But there is still more to do.
Although instances of mis-selling have been curbed, they haven’t stopped completely. Every time the capital market regulator comes out with stricter regulations, mutual fund houses and their channel partners find a way to achieve their objectives, perhaps, compromising the investors’ interest.
What should SEBI’s next action plan be?
1. Tighten the noose around close-ended schemes
Soon after the capital market regulator issued strict guidelines for open-ended mutual fund schemes for equity and debt both, fund houses floated more close-ended schemes.
New Fund Offers (NFOs) in the form of close-ended schemes not only help mutual fund houses grow their Assets Under Management (AUM), but also help escape the stringent rules applicable to open-ended schemes.
This is a major lacuna in the regulatory framework, and in the investors’ interest, the regulator must fix it with appropriate guidelines.
PersonalFN has highlighted the drawbacks of close-ended schemes on numerous occasions. Recently, it published a couple of articles to create awareness among investors:
The capital market regulator should take strict action against the irresponsible behaviour of mutual fund houses and their channel partners.
When the equity indices hit new highs, it’s relatively easy to convince, new investors. Mutual fund houses have mastered the art of playing with investors’ psyche to grow their AUM. They launch close-ended schemes, at a time, when valuations are stretched and committing more money to equity is risky.
As a result, most of the close-ended schemes underperform compared to their open-ended counterparts. In the name of offering stability to the scheme’s operations, “close-ended” nature of the schemes makes them less accountable and lethargic.
2. Do away with the dividend reinvestment option
Dividend reinvestment option, in our view, is a fool’s choice!
Those who do not want regular income should select growth option and those prefer to have occasional pay-outs, should choose dividend pay-out option.
Let’s first understand how these options work. Under growth options, the gains are accumulated and automatically retained and reinvested. In dividend option, at the discretion of the fund house, the gains are distributed among investors.
But under dividend reinvestment options, when the dividend is announced and paid, the proceeds are utilised to buy the units of the same fund at ex-dividend Net Asset Value (NAV).
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What’s the loss?
Dividends are tax-free in the hands of investors. But the mutual fund houses have to pay the dividend distribution tax before paying any dividend. Therefore, dividends aren’t totally tax-free.
Even as far as equity-oriented mutual fund schemes are concerned, the dividend option has become less attractive. As you may know, the Union Budget 2018 introduced dividend distribution tax @ 10% on equity-oriented mutual fund schemes.
Do you still think, dividend reinvestment option should stay?
Hopefully, the capital market regulator would also think on the similar lines.
PersonalFN has always encouraged investors to select their options carefully. Read some of the pertinent articles by clicking on the links below:
3. Discontinue monthly dividend options in balanced funds
As interest rates fell substantially over last three years, and sharply post-demonetisation; mutual funds started to attract conservative investors to balanced funds backed by a skewed narrative.
Since conservative investors have a strong preference for dividend-pay-outs, a few mutual fund houses launched monthly divided options.
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Recently, before the new financial year, many of mutual fund schemes paid dividends before dividend distribution tax on equity-oriented mutual funds being applicable. They were able to do so with huge gains made over last three-four years.
But such options are always misleading.
Under challenging market conditions, how many of these fund houses will be able to sustain the quantum of dividends they have distributed every month till now?
And let’s not forget, even if you as investors earn dividends and make losses on your capital, due to fall in the NAV post dividend distribution, the net effect is not positive.
4. End ‘copy-and-paste’ of liquid and liquid plus schemes
Observe carefully, many fund houses have similar liquid funds and liquid plus schemes (also known as ultra-short term schemes) in their product bouquet. It is challending to figure out the difference in their mandate and portfolio preferences.
But in this regard we are hopeful that the regulator will prudently regulate, as it did for scheme mergers of similar equity-oriented funds from the same mutual fund house.
5. Need to cap expense ratio of arbitrage funds
Arbitrage funds are classified as equity-oriented schemes for taxation purpose, but their return profile is comparable to that of liquid and liquid plus schemes (also known as ultra-short term schemes).
But their expense ratio is often near 1% –––rather high. Large commissions are paid to distributors to sell these funds.
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Until now, they were marketed as the tax-efficient alternatives to short-term debt schemes.
But soon after the government imposed dividend distribution tax and the long-term capital gains tax on equity-oriented schemes, they have lost their appeal.
PersonalFN has written some enlightening articles on arbitrage funds—comparing them with other available alternatives and explaining pros and cons of investing in them. Read:
The capital market regulator is playing a critical role in creating a fostering environment for all stakeholders: mutual fund houses, distributors, and investors.
Nonetheless, it is essential things that are beneficial for investors’ are done. If investors are happy, educated about invested, money will continue flow into mutual funds. Keeping this in mind, the regulator’s action on all the above mentioned issues would be crucial.
PersonalFN has always placed investors’ interest first!
We advise clients backed by thorough independent research, recognising their: risk profile, investment objectives, financial goals, and the investment time horizon before goals befall, among many other facets.
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The ideas in this article are inspired by Mr Pankaaj Maalde, and first appeared on ET and his blog.
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