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In Investors’ Interest

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The past few years have seen the regulatory framework for mutual funds undergo many changes. These changes have ranged from the fairly minor to fundamental ones that have forced asset management companies to make big changes to their business models.

For the most part, the changes make sense and have been in the interest of investors. Unfortunately, they have coincided with a generally poor environment in the equity markets, which has acted as a multiplier in terms of the stress it has produced in the asset management company's (AMC) business model. The effect of these forces is still playing out.

Entry Load Exits
The biggest change is the elimination of entry load, which was a deduction (generally 1-2 per cent) made from the investors' money at the time of investment, which went towards paying sellers' commission. Over the years, this upfront commission had degenerated into the main driver of fund sales. In stock market regulator Securities and Exchange Board of India's (Sebi) view, it was driving what is called mis-selling and fund churning (cycling investors' money in and out of funds to earn commissions).

NFO Curbs
There's a second big change that compliments this one — and that is the choking off of the New Fund Offer (NFO). The old business model of running a mutual fund in India was based on supplying a steady stream of new funds that were minor variations of each other.

AMCs could charge their expenses for launching a new fund to the fund itself, meaning they could take it out of investors' money. The closing of this route, along with Sebi's strictness in the last three years about permitting new funds, has forced AMCs to forget about the spend-and-sell NFO-based business model.

For investors, these changes have meant that there's no one conducting a high-pressure, in-your-face, sales campaign to make them invest in the latest mutual fund. Unfortunately, it has also meant that to some extent, there's no one trying to sell them any kind of fund at all. I believe that the business model is still evolving in response to the challenges that these regulatory changes have posed. It might well be that the business no longer has the financial headroom to expand its market but that remains to be seen.

Towards Transparency
Apart from these big-ticket changes, there have been a number of smaller changes. For example, a whole slew of changes have focused on controlling and making transparent risks in fixed-income funds, especially in shorter duration funds. These were triggered by the financial crisis of 2008 when some funds needed special liquidity assistance from the Reserve Bank of India in order to tide over the situation. Another set of changes pertains to ensuring truthful and standardised performance numbers.

Distributor Discipline
The one aspect of regulation that is still very much a work in progress pertains to fund distributors. So far, the market regulator has largely left this to the fund industry itself, which certifies distributors through the industry body, the Association of Mutual Funds in India. However, since distributors are investors' main interface, they can expect closer monitoring sooner rather than later.

The author is CEO of Value Research

(This story was published in Businessworld Issue Dated 30-04-2012)