Sebi wants MFs to be agile in stress events, warns industry on mis-selling

The total expense ratio on passive funds and direct plans are lower than the regular MF products.
The Securities and Exchange Board of India’s (Sebi’s) whole-time member G Mahalingam on Thursday pointed out that the risk-management practices of the Rs 27-trillion mutual fund (MF) industry can improve further. He urged MFs to create a framework that makes them gauge liquidity risks in a timely manner and mitigate liquidity pressure during stress scenarios.

The senior Sebi official said a tightening of norms in liquidity and overnight schemes that came in last year should be seen as nudges by the regulator to improve risk management practices of the industry.

While speaking at the 14th edition of CII Mutual Fund Summit, Mahalingam said MFs need to play a more constructive role when it comes to monitoring corporate governance practices followed in investee companies.

He questioned the practice of MFs staying away from casting their votes on company resolutions and pointed out that the ‘abstain’ votes were still as high as 12 per cent. He directed the MF industry to reduce ‘abstain’ votes to 1-2 per cent in the next few years.

He mentioned cases such as Fortis, Religare, and Crompton Greaves, while pointing out the growing prevalence of corporate governance issues.

He also warned the industry about mis-selling of MF products. “We don’t want to be in a situation where we get complaints from investors that they were not well-informed about the risk profile of the product,” he said.

He said that in the prevalent scenario, investors will aggressively look for yields and ‘alpha’ and it will be the duty of MFs and distributors to make sure there is no mis-selling.

Mahalingam cited the example of credit risk funds and said the industry needs to make sure investors coming in are aware of the inherent risks in such funds.

“While telling investors there is probability of 10 or 11 per cent returns, they should be told about the underlying risks,” he added.

“We expect alpha to become an obsession, as globally the returns generated are going down,” said Mahalingam.

He cited a Morgan Stanley study that showed a typical 60:40 equity-debt portfolio will only able to give 2.5 per cent returns over the long term.

The senior official told the industry to take more efforts to facilitate the growth of direct plans. He pointed out that the recent move by Sebi to allow MF investors to buy and sell units on exchanges could contribute significantly to the growth of direct plans.

He said that for further penetration of MFs, direct plans through technology can help the industry go to smaller cities or beyond the top 30 cities.

The regulator in the past had also asked the industry to focus more on driving the growth of direct plans, as cost of investing is lower in such plans. Mahalingam also asked industry to drive the growth of passive funds to give investors more options of lower-cost funds.

According to the current regulatory framework, the total expense ratio on passive funds and direct plans are lower than the regular MF products.

Mahalingam also asked the industry to focus on building a more sustainable business model by building a larger retail asset base. Retail investors tend to be sticky unlike the volatility in flows seen in institutional investors.

While acknowledging the change in regulations can lead to further operational costs for MFs, Mahalingam said the industry needs to look at the business as a volume-based one to absorb these cost pressures. He said the industry can build scale through investor-friendly moves.

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