At the CII Mutual Fund Summit held in Mumbai yesterday, SEBI Whole Time Member G Mahalingam shares his views on the asset management industry. His perspective was very important considering that the industry is booming. He pointed out that post demonetization, the extra liquidity floating in the system is around Rs 3-4 lakh crore, a substantial part of which is finding its way into the mutual fund industry. While the industry is riding on a bull run, he also cautioned that the players need to look at risk more closely while generating alpha.
Here are his views on various issues related to the asset management industry.
Total Expense Ratios
Following global cues around expense ratios, the Securities and Exchange Board of India, or SEBI, is actively scrutinizing the fees charged by asset management companies and is contemplating a discussion paper on the same.
Mahalingam pointed out that on the back of this bull run, investors are merely looking at the superior returns generated by the industry and overlooking fees. However, when the market does correct, expense ratios will come into sharper focus.
Our view: It could get increasingly difficult to beat the benchmarks once SEBI’s norms on scheme categorization are implemented. For instance, SEBI’s new guidelines on product rationalization mandate large-cap funds to invest 80% of the scheme’s net assets in the top 100 companies by market capitalization. Added to that, the move towards benchmarking schemes against Total Return Index (TRI) could make it even more difficult for asset managers to showcase alpha, especially in the large-cap category.
Morningstar compared the alpha generated by large-cap funds over the broader market benchmark, both on Price Return Index (PRI) as well as Total Return Index (TRI). Over a 5-year basis, the TR of the S&P BSE 100 is 165 bps p.a. higher than the PR. As expected, the number of funds beating the benchmark dropped from 85% to 58% after making a comparison with the TRI instead of the PRI.
Mutual funds in India charge a fixed slab based fee which is tied to the fund size. Countries such as New Zealand and Denmark allow mutual funds to charge performance-based fee with no equal reduction in fees for underperformance.
Nevertheless, the debate around rationalizing TERs in India is only expected to gain momentum. Few industry experts even pointed out that the extra incentive offered to B15 distributors needs to be relooked.
Gear up for turbulent times
He cautioned fund houses to prepare for turbulent times post the Federal Reserve rate hike of 50-75 basis points which is expected to be announced in 2018.
“The banking system credit has shown some signs of growth. There has been an uptick in the banking credit compared to the bank deposit growth. This is a nascent sign of green shoots in the economy. The real interest rate in India is close to 2.5%. If the real interest rate in U.S. goes up and the difference between the real interest rate between India and U.S. comes down, we could see some reversal of fund flows. If the flows in the mutual fund industry temporarily abate, that will be a new normal for the industry. The Indian currency reaction to the Fed rate hike will also determine the fund flows in India,” pointed out Mahalingam.
Global trends
Mahalingam noted that the focus is shifting from banking to the asset management industry, especially around the need to designate mutual funds as Systemically Important Financial Institutions (SIFI). While globally asset managers have vehemently opposed this tag, he said that the Indian regulators need to ponder over this in the wake of increasing interconnectedness between banks, mutual funds and insurance in India to ensure macro stability.
“In situations where the senior debt instruments of a troubled bank are held by other financial institutions, such as other banks/ mutual funds/ pension funds/ insurance companies, a write-down of senior debt can trigger systemic repercussions that an effective resolution regime is required to avoid. In the event of uninsured depositors coming within the scope of bail-in, a bank run could be triggered and even lead to contagion and systemic risk,” states an RBI report on Framework for Resolution of Financial Institutions.
In this context, Mahalingam made a case for Indian asset managers to have minimum capital or loss absorbing capacity to build a wall of protection despite the fact that mutual funds are pass-through vehicles.
Fee versus Commission
SEBI is currently studying global advisory practices to ascertain the implications of various advisory models and the impact they have had on investors.
In the United Kingdom, the rules associated with Retail Distribution Review (RDR) are explicitly designed to eliminate any linkage between fund selection by advisers and the payment of commissions by fund houses. As of January 1, 2013, advisers, unless they elect only to offer ‘basic advice’, are banned from receiving commission payments from fund houses.
Our view: Morningstar research shows that while a number of markets have moved away from paying commissions, in 15 of 25 markets, advisers are still paid predominantly through commissions.
Liquidity
The industry needs to come up with a solution to tackle liquidity. “In 2013, we went through a jiffy because of the huge amount of global volatility in the wake of Ben Bernanke’s statement on tapering off. Thankfully, the mutual fund industry was completely insulated from this crisis. It is a moot question that whether we can rest on the past laurels and say we don’t need any liquidity requirement,” said Mahalingam.
Focus on ETFs
He nudged the industry to focus on promoting ETFs which will gain prominence as our market matures, especially when the alpha generating ability of fund mangers comes under pressure.
