In its constant endeavour to protect investors’ interest, SEBI has taken several bold measures over the past few months for mutual fund houses to become more accountable and transparent for their actions.
SEBI has taken most of these measures in the wake of the Franklin Templeton mutual fund fiasco. According to SEBI’s findings, some top executives of the fund house withdrew their investment in the six debt schemes just before they were abruptly wound up. The six schemes were run akin to credit risk funds even though the six schemes had different characteristics. This has induced SEBI to deepen mutual fund’s skin in the game.
In simple terms, ‘skin in the game’ is a rule which implies a fund house/mutual fund scheme’s willingness to align their interest with that of the investors. SEBI’s recent move works on the assumption that the higher a mutual fund scheme’s stake in the schemes, the better its actions will be in the interest of the investors.
Consequently, based on the recommendation of the Mutual Fund Advisory Committee, SEBI has decided to link the contribution from asset management companies in mutual fund schemes to the risk associated with it. Meaning, higher the risk of the scheme, higher the contribution of the asset management company will be in that particular scheme.
SEBI’s rationale for skin in the game for mutual fund
Mutual fund schemes are required to depict the level of risk a mutual fund scheme carries through a risk-o-meter. Fund houses evaluate the risk level of a scheme based on its portfolio. The fund management team has the flexibility to manage assets and liabilities of the scheme. Therefore, it is a possibility that for some schemes, fund managers may resort to aggressive bets to enhance short term returns, which may not necessarily be in the interest of the unitholders in the long term. Thus, ‘skin in the game’ is important to align the interest of the asset management company and its employees with the interest of the unitholders.
At present, asset management companies are required to provide investment of 1% of the amount raised in New Fund Offer (NFO) or Rs 50 lakh (as per a 2014 regulation), whichever is less. The AUM of mutual fund schemes has increased from Rs 8.25 trillion as on May 2014 to around Rs 33 trillion as of May 2021. But the investment by asset management companies in mutual fund schemes has not increased in tandem.
Subsequently, SEBI has decided to revise the quantum of minimum contribution in mutual fund scheme as a percentage of AUM vis-a-vis the risk as under:
|Risk Value||Risk level as per Risk-O-Meter||Minimum % of AUM to be invested in scheme|
|>1 to ≤ 2||Low to Moderate||0.05|
|>2 to ≤ 3||Moderate||0.07|
|>3 to ≤ 4||Moderately High||0.09|
|>4 to ≤ 5||High||0.11|
The fund houses may therefore have to invest a higher amount in its scheme depending on the risk level. According to SEBI, the new regulations will come into effect on the 270th day from the date of their publication in the Official Gazette.
All the schemes will have to maintain the investment till the scheme is wound up or till the completion of tenure of the scheme. Additionally, the investments will be subject to quarterly review to ensure compliance with rule in line with the change in AUM or change in risk value assigned to the scheme. However, the contribution from the asset management company will not apply to ETFs, Index Funds, Overnight Funds, Fund of Funds schemes, and existing close-ended scheme.
In case of violation of the above-mentioned provisions SEBI can initiate the following actions:
(a) Suspend the launch of any scheme of a mutual fund for a period not exceeding one year
(b) Forfeit the amount invested by an asset management company in any of its schemes
However, SEBI will pass such order/s only after giving the asset management company an opportunity for a fair hearing.
Earlier, with a view to enhance mutual fund’s skin in the game, SEBI had decided that a part of compensation, i.e. a minimum 20% of the salary/ perks/ bonus/ non-cash compensation of gross annual CTC, net of income tax, and any statutory contributions such as, PF and NPS of the Key Employees of the AMCs will be paid in the form of units of Mutual Fund schemes in which they have a role/ oversight.
SEBI expects that getting key employees to invest in the schemes they manage can lead to better accountability of the fund management team. These measures are implemented for better quality of securities and improvement in the scheme’s performance. Moreover, investors, in general, will have a more confidence in a scheme if the fund manager’s interest aligns with their own.
How will investors benefit from skin in the game?
Over the past few years we have seen fund houses launch an increasing number of scheme in risky categories, such as Thematic and Sector-oriented funds. Fund houses position these schemes as unique and high return propositions to lure investors. However, these funds are highly risky and often only suitable for savvy investors.
SEBI’s skin in the game rule, to an extent, could discourage fund houses from launching such risky schemes. However, hefty investments by fund house and its key employees in particular scheme does not guarantee improved performance.
It is important to select worthy schemes after evaluating it on various quantitative and qualitative parameters. Select schemes that align with your risk profile, investment horizon, and financial goals.
This article first appeared on PersonalFN here