Have the Indian regulatory actions been reactive? What governance and oversight mechanisms do fund houses have in terms of their investment decisions and risk management practices? How does India fare in comparison to global best practices and what can be done to make our industry robust?
At the recent Morningstar Investment Conference 2020, Nilesh Shah, Managing Director, Kotak Mutual Fund, Sandeep Parekh, Founder Finsec Law Advisors, and Aron Szapiro, Head of Policy Research, Morningstar Inc engaged in a discussion with Jiju Vidyadharan, Head of India Business, Morningstar India.
Here are some key highlights from this discussion.
What steps is the industry taking to increase trust among investors?
Nilesh Shah: Morningstar report has noted that the Indian fund industry ranks better than developed counterparts when it comes to transparency. We believe our expense ratio is far lower than in developed worlds. In terms of performance, most Indian fund managers outperform benchmark indexes despite constraints. In developed markets, active managers are struggling to beat the benchmark. So whatever steps are necessary to increase investor confidence and trust, fund houses and the industry body are willing to walk on the same path.
Sandeep Parekh: SEBI has worked on four areas to strengthen the industry:
1. SEBI has put a cap on total expense ratio and also defined the sub limits in terms of how much can be spent for each category of expense.
2. Fund houses disclose a lot of data on schemes, performance, portfolio, distributor remuneration, etc. Each scheme shows a risk-o-meter for investors to assess the risk of the fund. This helps retail investors.
3. It has curbed mis-selling in the mutual fund industry to a large extent. There is still some mis-selling outside of the mutual fund industry though.
4. SEBI and AMFI had defined a code of conduct for the industry and intermediaries. For instance, there is a mechanism to ascertain the price for inter scheme transfer. There are costs attached to complying with all these regulations, but it benefits in the long run. This is evident by the decent growth recorded by the industry in the last five years.
Aron Szapiro: In terms of risk disclosure, U.S. lags behind. There is a proposal to have a two-page summary report of the various risks each fund faces. Currently, funds mention every conceivable risk that a lawyer could come up with which is not of much use for investors. Morningstar provides a lot of data on risks which helps investors make an informed choice.
In the European markets, the industry is trying to figure out a way to adopt a standardised risk disclosure framework that all products (mutual funds and insurance) can adopt. It is based on value at risk.
In developed markets, funds are required to hold a portion of investments in liquid assets to meet redemption pressure. Some regulators require the industry to adopt a risk management programme. There is no one size fits all rule for liquidity as different funds have different investment strategies and risks. But largely, many funds have managed to meet liquidity requirements well.
With the information overload, in terms of disclosure, what data is pertinent for investors?
Nilesh Shah: We need to disclose as much data as possible. Each investor processes a piece of data differently. So there should be no restriction of data for investors. We should let them choose what is appropriate for them. However, we need to have some accountability for misinterpreting data.
Very often, the industry gets negative publicity whenever funds underperform for certain periods, or certain one-off events occur which do not impact the entire industry. So the investor community gets misled that the industry is in trouble.
Do regulators in other markets define portfolio construction methodology for different fund categories?
Aron Szapiro: There is a long history of regulating product names in the U.S. as well as in other countries. In the U.S., for instance, if the fund’s name is large cap, then 80% of the fund’s assets need to invest in large caps. Further, the fund's name should truly reflect the investment strategy of the scheme.
This ensures that funds are true to label. But you do need a real human being to assess whether there's anything else is misleading. For instance, fund managers in a low yield environment invest 80% in bonds and invest the remaining 20% in risky assets to generate alpha. Thus, bond funds should not ideally invest in equities, if they are projecting such funds as safe.
Now another area where this has just not been cracked either here or abroad, are these increasingly popular target-date funds. These funds have a glide path where they change the asset allocation over time. It starts at 90% in equities, 10% bonds, and then shifts over time, and nobody has really found a good way to regulate the naming conventions of such funds. You will find that one company's conservative target-date fund for a target year is a bit more aggressive than the other.
Fund labeling is also challenging when it comes to thematic funds like sustainability-oriented funds or impact funds. There is no environmental, social and governance, or ESG, asset. You cannot have a common definition for ESG assets. You can have layered disclosure. Funds disclose voluminous information, so investors who are really interested can dig into it. But what most investors need is a simple summary statement that mentions fund strategy, how it will invest and some accountability to adhere to it.
Has the industry communicated the risks to investors properly?
Sandeep Parekh: Securities and Exchange Board of India, or SEBI, is constantly working at making fund’s true to label. It does not allow an AMC to launch two large cap funds. Some people in developed markets may find it intrusive. In developed markets, it is a more laissez-faire system. I think Indian mutual funds are true to label and easy to understand. The industry is evolving.
Nilesh Shah: The regulator is working towards mandating more disclosures for fixed income funds. Going ahead, investors will have a clear idea of duration, maturity and credit risk.
SEBI has recently come out with guidelines for inter scheme transfers. How feasible would be the implementation?
Nilesh Shah: There's no restriction to transfer from one scheme to another scheme. Now, if my liability side can be transferred, why can't my asset side be transferred? And the risk on the asset side getting transferred from one scheme to another scheme is related to pricing. Anyway, we have given up that pricing to an independent valuer. So whatever valuation independent valuer was deciding we were transferring. In developed markets, if scheme A is buying and scheme B is selling then the transaction cost is netted off and saved. In India, we incur transaction cost to execute such transactions.
How are trustees playing their role in guiding asset management companies in the U.S.?
Aron Szapiro: Funds should have a governing board with independent directors. Some countries have even recently changed, the U.K., for example over the past couple of years, required 25% of the board to be independent. Besides, it is really important to have training to get trustees to think about their roles, is in terms of the trustee's role as – for voting proxies of the companies that they hold as stewards.
Morningstar's independent board of trustees for the Morningstar funds that are available in the U.S., recently submitted a comment letter to the Securities and Exchange Commission, in regard to a new disclosure. They conveyed to investors in our fund that we as the board of directors, are always there to serve investors and not to just sell the fund or to make money. I thought that was a really good way of thinking about the right orientation and attitude that you want to convey -- to directors, the trustees of a mutual fund.
How are trustees being empowered in India?
Nilesh Shah: The institution of the board of trustees is evolving. It started in mid-90s. SEBI has done a fairly good job in empowering the board of trustees. So, for example, we are probably one of the few mutual funds in the country, which actually pays much higher trustee fees to our trustee company. They built a network in the trustee company so that the money can be used for seeking professional help and employ the best talent in the industry so that they can carry out their work efficiently.
The board of trustees are watchdog of the asset management industry. Their responsibility lies with investors and regulators. They are not responsible for the AMC's profitability or fund managers performance. Have we reached Nirvana in trusteeship? The answer is no. Have we come a long way compared to what we were in the past? The answer is yes.
