In a move that can be a step ahead in protecting the interest of investors in mutual funds, the capital market regulator – Securities and Exchange Board of India (SEBI) has showed its desire to limit the rights of the asset managers to charge fund management fees, for which they can be eligible only if they are able to perform. This move can stop money losing mutual fund schemes from charging fees to the investors who might have already lost a portion of their money by being invested in underperforming funds.

Many mutual funds have set example of not being able to build a strong performance track record and yet eye for a bigger share in the corpus pie. Even though the funds of some fund houses have been delivering poor returns to their investors over the past 3 to 5 years, there has been no specific reason for them to add funds in their kitty by launching new ones. Yet while managing a number of schemes with lacklustre track record, they aim to launch new schemes which can bring them fresh money. This shows the preference of many mutual fund houses to get business from new investors, instead of putting effort to improve performance for its existing investors. The investors on the other hand have ended up paying for the mediocre performance of the fund managers. Mutual funds can charge total expense ratio of upto 3% p.a. from its investors of which the fund management fees is around 1% p.a.; even with discouraging performance, many asset managers have kept their overall charges on the higher side.

SEBI has issued many guidelines to mutual funds from time to time to protect the interests of investors. In order to curb mis-selling on back of short term performance track record of any outperforming scheme from the fund house; SEBI had few months back passed a guideline to compulsorily show the performance (vis-à-vis benchmark index) of all the schemes managed by the fund manager in the funds factsheet. And over the past six months SEBI has been planning to deny approval for launching new schemes, to fund houses whose schemes have consistently been underperforming over the last few years. Now SEBI wants explanation from AMCs on why they should be allowed to charge fees, when they have failed on their role and their schemes have underperformed the benchmark index, thereby disappointing its investors. It also seeks explanation from the fund houses mentioning the reason behind continuing the non-performing schemes instead of winding them before launching a new one. SEBI has also refused to clear applications for launching new funds received from mutual funds that already have some non-performing funds under their kitty.

While in the past SEBI has questioned mutual fund houses over their performance and launching of unnecessary schemes, the practice of charging fees (within stated limits) irrespective of their performance was till now never objected by SEBI. This can put pressure on mutual funds to improve performance of their existing mutual fund schemes and deliver returns superior to their respective benchmark indices, in order to be eligible for compensation. To clean their performance track record, over the past two-three years, many mutual fund houses have merged their underperforming funds with their other decent performing funds. Though this strategy has reduced the list of underperforming funds for the fund house, it has failed to heal the wound of investors who have already suffered losses in such underperforming funds.

In our view, restriction on the fund management fees cannot be the only option for mutual funds to improve on the performance front. Improving the performance of the funds require many other developments like improving and streamlining the fund management process, guidelines to create a solid research and fund management team, solid risk management, restriction on the number of schemes managed by a single fund manager, restriction on exposure to highly sensitive sectors, restriction on investing in stocks of companies managed by elusive management etc.

Linking the compensation of the fund house to the performance of schemes may increase the chances of encouraging asset managers to take some risky bets, in order to make some quick gains to show improvement in performance and safeguard their management fees. The fund house should focus on simultaneously improving the track record of all the funds in its kitty and it cannot concentrate on promoting just selective funds that have topped the performance chart in the recent past. Fund houses have to be accountable for both, their top performing as well as bottom performing funds, which should be compulsorily disclosed to the investors while promoting their popular funds to the investors. Even investors should monitor their investments on a regular basisA and take timely corrective measures, if they feel their fund managers have been continuously failing on their task.

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Comments
shijayenterprises@gmail.com Apr 04, 2013 very good article enlightening the investors, need to bring such articles.  The AUMs to be held responsible and not to charge for the period they fail to perform.
mfvblogs@gmail.com Mar 01, 2013 Thank you for the resourceful article.

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