Ever since credit rating downgrades exposed investors in debt mutual funds to high risk, including the ones who had parked money in liquid funds, the capital market regulator has been on the vigil.
A need was felt to review the regulatory framework and take necessary steps to safeguard the interest of investors and maintain the orderliness and robustness of mutual funds.
Moving further in that direction, recently, vide a circular dated August 16, 2019, the Securities and Exchange Board of India (SEBI) has restrained mutual fund houses or Asset Management Companies (AMCs) from parking the assets of a scheme in Short Term Deposits (STDs) of a bank which has invested in the scheme.
…It is clarified that Trustees/Asset Management Companies (AMCs) shall ensure that no funds of a scheme is parked in STD of a bank which has invested in that scheme. – SEBI Circular (SEBI/HO/IMD/DF4/CIR/P/2019/093)
(Image source: pixabay.com; photo credit: succo)
What’s more?
The capital market regulator has even asked AMCs to make sure that the bank in which the scheme has an STD does not invest in the respective scheme until the scheme has an STD with such a bank.
Trustees/AMCs shall also ensure that the bank in which a scheme has STD do not invest in the said scheme until the scheme has STD with such bank. – SEBI Circular (SEBI/HO/IMD/DF4/CIR/P/2019/093)
The objective…
This is been done to protect the interest of investors in the securities market from related party transactions, whereby the vested interest of parties shall be done away with, and at the same time promote the development of securities market at large.
In the past, too, the capital regulator has taken a number of measures in the interest of investors such as:
Ban on entry load (in August 2009)
Ban on upfront commission and new commission disclosure norms
Uniform fact sheets
Made mutual fund houses apply product labels with colour codes and risk-o-meter
Revised the expense ratio, bringing down the cost of investing
Introduction of Direct Plan for a mutual fund scheme
Prudential norms governing liquid funds and other debt & money market instruments
Changed valuation norms for below-investment grade securities
Asked mutual fund houses to shift all their investment to listed or to-be-listed equity and debt securities in a phased manner and reduce their exposure to unrated debt instruments from 25% to just 5%
And even pulled up credit rating agencies for their high laxity and enhanced their disclosure norms
[Read: Should The Rating Agencies Be Blamed For This Credit Crisis?]
Post the IL&FS, DHFL, Reliance ADAG, and Essel Group debt episodes, SEBI has moved swiftly taking a number of measures vide the necessary diktats and guidelines in an effort to ensure that the Indian mutual fund industry follows the best practices weighing the undercurrents.
Summing up…
The continual refining of risk management framework by the capital market regulator, learning from experiences on the ground, is very welcome and worth appreciating. It will tighten the grip on mutual funds; make mutual fund houses more accountable for their actions, and in turn, get them to fall in line so that the interest of investors’ is safeguarded and it boosts their confidence.
Advice for investors…
While the capital regulator is doing its best to protect your interest, do not assume debt funds to be safe. Remember, investing in debt funds is not risk-free.
[Read: Are You Holding Debt Mutual Funds With Stressed Assets?]
Approach even short-term debt funds with your eyes wide open and pay attention to the portfolio characteristics and quality of the scheme. The fact is many debt funds across maturity profiles already have exposure to downgraded and toxic debt papers, which heightens the investment risk.
So, prefer safety of principal over return. Stick to mutual funds where the fund manager doesn’t chase returns by taking higher credit risk. Choose debt schemes offered by mutual fund houses which follow robust investment processes and have adequate risk management systems in place.
And, finally, when you invest in debt mutual fund schemes, assess your risk appetite, the financial goals you are addressing, time horizon before goals befall, and follow your personalised asset allocation.
This article first appeared on PersonalFN here.
