MF Wrap: SEBI disciplining Mutual Funds—trickle down effect to other financial segments

It has been a month since June 28, 2019 board meeting of SEBI that created ripples of change in mutual fund practices.

That Board meeting, SEBI had categorically opined for mutual funds to remain core investing institutions and not play shadow bankers.

The hint was to mutual funds as well as corporate who got used to taking mutual fund resources as guaranteed lending points.

But this is not the first time a big splash made in mutual fund reforms.

Back in 2009, SEBI went ahead and banned upfront commissions to mutual fund distributors cum advisors letting them earn annual commissions depending on how long investor stayed in the recommended schemes.

Gradually the limits on annual commissions were cut down.

With mutual fund reforms still running, the other financial segments too had a rub-on effect. This piece attempts to look at a few of these.

Pledged promoter shares going down

With SEBI raising eyebrows on rampant MF lending against pledged promoter shares culminating in series of defaults like Essel, ADAG group, DHFL, among others.

SEBI measures to tighten pledging has resulted in reduction of pledging practice by promoters.

SEBI has placed closer scrutiny on MF practices of loan against shares, LAS plus new SEBI rules require detailed reasons for each pledge separately where promoters’ shares is more than 20 percent of the total share capital of company or 50 percent of the total promoter holding.

The results are there to see. As per Prime database, pledged shares fell to around 10 percent of total promoter holdings in June 2019 quarter, the lowest in six years.

Clearly, pledges were increasing earlier with a design to borrow heavily from MFs and other financial institutions, now with SEBI curbing such MF lending, this corporate financing practice is slowing down.

The Prime database also reveals Adani Ports, GMR Infra, Emami, Indiabulls group are among 75 promoters that redeemed their pledges in June 2019.

Liquid fund investors shifting to Overnight funds

SEBI for first time introduced graded exit load for exits in liquid funds. Liquid funds are short duration funds with less than 91 day securities, these funds mainly cater to corporate treasury investments. Such corporate investors are not used to exit loads for keeping money for less than 3-month periods.

With new norms of exit load in liquid funds, corporate very short term investments will move to their rightful place, the overnight funds which are ultra-liquid fund in nature with instant maturing securities investment profiles.

In overnight funds, the portfolio is oriented for instant liquidity and safety so that investors can redeem their money at short notice without any risk of losing value in the capital parked.

Earlier liquid funds of 91 day type duration were giving superior returns compared to overnight funds due to valuation in liquid funds done on historical basis.

In early 2019 SEBI mandated mark to market fair valuation in liquid funds that uncovered the problematic debt papers in these schemes.

Since then liquid funds faced declining or volatile NAV which corporate short term monies were not used to. Now, these monies are looking for non-volatile investment destination in safe overnight funds or bank FDs.

Cost Structure and clean practices of Mutual Funds in PMS and AIF

What cost rationalisation reforms SEBI started with mutual funds in 2009 is now extending it to Portfolio management services (PMS) and Alternative Investment funds (AIFs).

SEBI is reportedly working on rules for limits on selling commissions for PMS and AIF plans.

Currently PMS is for investors with minimum Rs 25 lakh rupees and AIF for hedge funds with minimum Rs 1 crore.

It was earlier thought that such high net worth investor would be well aware of costs borne in investments and that retail MF investor needs more careful and detailed handling of regulatory protection by SEBI, said a former SEBI officer having worked in its mutual fund department.

Of late, there have been incidents and murmurs of distributors now aggressively pushing highly priced PMS and AIF plans after getting huge upfront from asset managers.

In rush for earning upfront incentives where the PMS and AIF does not have a demonstrated track record, the merits and risks of the investment is pushed to backseats. Stoppage of upfront in mutual funds has moved distributors to promote PMS more.

Buzz is that SEBI has asked for industry player consultations to embark on reducing the cost structure of PMS and AIFs.

Whether SEBI abrogates upfront commission model or puts a cap limit to it along with annual trail commission model, remains to be seen.

Either way, the day it takes place, India may be the first jurisdiction among prominent securities markets where high net worth investors plans will have regulatory oversight in cost structures.