The Judiciary system is one of the four pillars of democracy. Citizens of a democratic country are bound by the law. If you have any experience in dealing with court cases, you know how important it is to put forward the details of your case in a neat manner and in legally accepted parlance to enhance your chances of winning the case. However, sometimes it can happen that the party you are dealing with has done nothing wrong, legally, but on moral grounds may have a lot to answer. The best way to deal with it is gently/diplomatically yet smartly. Confused? The State Bank of India (SBI) showed the way recently. Here's the background story first.

A few months ago, this was the case of a couple of mutual fund schemes …

JP Morgan Mutual Fund invested in debt securities of Amtek Auto through two of its schemes, JPMorgan India Short Term Income Fund and JPMorgan India Treasury Fund. When Amtek Auto failed to honour the repayment of its loans, the schemes suffered a huge loss. This was not a one-off instance.

There were many cases where the investment decisions of mutual funds defied logic. Reputed mutual fund houses such as Franklin Templeton, ICICI Mutual Fund, and Reliance Mutual Fund have exposure to debt securities of debt-laden and troubled companies such as Jindal Steel and Power Limited (JSPL). Even the Securities & Exchange Board of India (SEBI) enquired about the exposure of mutual funds to JSPL after an independent credit rating agency reassessed the company's debt rating to a lower one.

This brought to light pertinent questions.

Are mutual funds doing anything that is against law? No. They are operating well within their business regulations. Are they committing fraud or joining hands with the company's management to aid raising money? Apparently, with information available at present, they are not perpetrating these misdeeds either.

So where are the discrepancies? The possibility is that they are not exercising due diligence in the true sense. It turns out fund managers are basing their investment decisions primarily on the credit rating a company receives from an independent rating agency. In other words, if the assessment of the credit rating agency goes wrong; the mutual funds investors are bound to suffer. The common perception is that mutual fund houses are not doing enough homework nor are they doing it right.

The point that can't be ignored is the common man invests in mutual funds influenced by the credibility of a fund house. So if a credit rating agency fails to accurately assess the risk involved in investing, mutual funds can't turn their back on investors claiming they invested in securities with better credit rating. They should assess these on their own; they are the experts after all.

The SBI game changer

The SBI has sent letters to mutual fund houses seeking clarification on the processes mutual funds follow to safeguard their investors from possible loss. A story about this topic published in Economic Times dated October 15, 2015 reveals the details of the SBI letters:

"Methods to deal with suspension of rating of an investment and client compensation policy in the event of a default.”

Besides, there are five more questions that contest investment policies of mutual funds with respect to liquid funds and liquid plus funds as well as other shorter duration debt funds. India's largest banker also wants to know if any fund manager has trespassed any investment mandate.

Mutual funds are now in a 'Catch 22' situation. While they may successfully answer most of the questions raised, framing a reply on "client compensation policy” is likely to complicate things for them.

Mutual fund houses have to face the music now. By law, they can't offer any guarantees to investors and until they give satisfactory answers to SBI; else, their business will always be threatened. There's another side effect. Other large institutional investors too may start asking tough questions, going forward. So far, mutual funds have been effectively dealing with consumer grievances by tactfully framing disclaimers.

This deft-touch of SBI has tossed a coin and shaken up mutual funds. Heads, investors win; tails, mutual funds lose. The only possible way out for mutual funds would be to come clean and be morally accountable for all their actions.

"Mutual funds are subject to market risks”, but time has come to say, 'growth in Assets under Management (AUM) is subject to inaction risks.' Fund houses may have to become more proactive in managing risks, associated with investing, if they want to protect their business, else debt funds may see outflows of a large magnitude in days to come.
 

Add Comments