MFs must tighten controls to prevent front-running

Back in June this year, market regulator Securities and Exchange Board of India (Sebi) revealed that an investigation had revealed that an equities dealer at HDFC Mutual Fund had been misusing his position to illegally make money in the stock markets.

This dealer would leak advance information of the mutual funds’ stock trades to his accomplices. They would then buy and sell before HDFC Mutual Fund itself did, thereby making money for themselves while causing incidental loss to the mutual fund, or rather, to the mutual fund’s investors.

At that time, Sebi fined HDFC Mutual Fund and banned Nilesh Kapadia (the rogue dealer) from participating in the securities market. It also asked HDFC to overhaul its internal controls and procedures to ensure that this sort of thing didn’t happen again.

I had heard that the incident had triggered panicked reaction in a large number of businesses that trade in equities on behalf of investors. Mutual funds, portfolio management services and insurance companies scrambled to figure out how vulnerable they were to something like this.

From what I know, many of them came to the conclusion that they could not guarantee that a determined and clever operator would not do the same thing. However, as far as investors were concerned, the matter seemed to blow over. Certainly, HDFC Mutual Fund itself seems to have gotten away without any detectable damage to its image among investors.

However, a couple of days ago, a more alarming piece of news has come out. Sebi has stated that it is now engaged in investigating 10 more mutual funds companies for possible cases of front-running. At this stage, they are just investigating and Sebi may or may not discover any actual wrong-doing. Also, it is notable that Sebi did not come out with this information willingly. Instead, it revealed it only in response to an Right To Information (RTI) request by a newspaper.

However, no matter how the investigations go, it is clear that front-running can only be curbed by organisations if they are internally committed to doing so. One important component of this commitment is that such actions should get exemplary punishment. Not just that, the responsibility for laxity in internal controls should actually be considered the real cause for losses suffered by investors. And these things should be done and not just seen as being done.
Those who manage other people’s money have a finite amount of trust and trust once spent is hard to earn back.

Source: http://economictimes.indiatimes.com/personal-finance/mutual-funds/analysis/MFs-must-tighten-controls-to-prevent-front-running/articleshow/6726754.cms

Amfi to become self-regulatory

No longer content with being just an industry association and trade body for the Rs7.13 trillion mutual fund industry, the Association of Mutual Funds in India (Amfi) is taking baby-steps towards becoming a self-regulatory organization.

In an interview, newly elected Amfi chairman U.K. Sinha refused to specify a time frame for the planned transformation, but said the objective is on his agenda. “The capital market regulator, Securities and Exchange Board of India (Sebi), has been asking Amfi to do this for quite some time. We’ll consult Sebi on the matter and soon start the groundwork to move in this direction,” he said.

Sebi now regulates mutual funds, but Sinha says the industry, with 41 asset management companies and at least 100,000 distributors, is too large and intricate for the market regulator to oversee every detail.

Amfi must move beyond being just an industry body. We have to engage other players who are on the periphery. Presently Amfi doesn’t have any representation from distributors or registrar and transfer agents. Ultimately Amfi must become a self-regulatory organization (SRO). We have also started talking to Sebi (Securities and Exchange Board of India) more actively. We would also like to work towards developing a mutual fund (MF) policy.

Tell us more about this policy.

For a variety of reasons, we observe that MFs are being perceived as a short-term vehicle and it is an aggregator for liquid assets of firms. That is just one part of our overall existence; to say that that is our only objective is a wrong impression. I protest.

The policy statement will define the industry’s role, list out measures to reach out to small towns, small investors, the MF industry’s obligations and thereafter its responsibilities. We have seen policies in the banking, civil aviation, insurance and even the pension sector.

Do such policies work? Many still can’t borrow from banks, non-remunerative flight sectors go empty. However, mobile phones (an area without policy) get penetration. Aren’t we going back 25 years?

I don’t think we can call these examples as failures. Maybe they have not been able to meet their expectations. For instance, if 40% of a bank’s advances has to go to the priority sector, banks have to set aside that money. Whether it reaches the final destination can be a question we can ask.

MF pension products are excluded from the tax deduction instruments under the new Direct Taxes Code. What also hurts the MFs is the differential treatment. There will be no harm to get clarity on this from the government and the regulator.

But, despite tight regulations and strong performance, why is it so difficult to get your message across to the investor?

Low financial literacy is a problem. Competitive products can offer incentives; the MF industry can’t. Since 2003, when the markets were going up, there has never been a year when retail equity inflows in the industry has been negative. But since last one year, the retail equity inflows has been negative. In fact, we are losing around Rs3,000 crore per month on average. The number of folios is dwindling. This is also why the New Pension Scheme has not taken off despite being a good product because there is no incentive for distributors. So we have to recognize that if there are other products where it’s possible for people selling them to be incentivized in a better way, a product which doesn’t pay incentives—no matter how good it is—will be at a disadvantage.

Are we talking of a move back to a system of paying incentives?

It is too early to comment on how the policy would shape up on this issue, but I am flagging this is as one of the issues. Fortunately, we have evidence of the past 15 years. If the government or the regulator is convinced that MF is a good product for retail investors, then a suitable incentive plan can be devised.

Would an incentive-based structure address the problems of mis-selling if adviser regulations are in place?

Yes it would. The absence of distributor regulation is a big lacuna.

Would Amfi—as an SRO—be interested in taking the leading and devising distributor regulations, at least for distributors selling MFs?

We have not discussed this with Sebi or with the distribution industry; I’d be speaking out of turn, if I say we will do this. Though I think Amfi should move in that direction.

Source: http://www.livemint.com/2010/10/11000607/Amfi-to-become-selfregulatory.html?h=A1

Making MF transfers easy — Nominee for your funds

Registering a nomination facilitates easy transfer of funds to the nominee on the demise of the investor.

What is a Nomination?

An investor can nominate a person(s) called nominee(s) to whom his/her Mutual Fund Units will be transferred on his / her demise.

Mutual Fund units get transferred to the nominee registered in the folio on the demise of the Investor.

What are the benefits of registering a nomination?

Registering a nomination facilitates easy transfer of funds to the nominee(s) on the demise of the investor. In the absence of the nominee, a claimant would have to produce a host of documents like a Will, Legal Heir-ship Certificate, No-objection Certificate from other legal heirs etc. to get the units transferred. The process is simple if a nominee is registered in the folio.

How can an investor make a nomination?

Nomination can be registered at the time of purchasing the units. While filling in the application form, there is a provision to fill in the nomination details.

Alternatively, an investor may register a nomination later through a form which may be submitted with relevant particulars of the nominee.

The forms are available on the mutual fund websites.

Investors may also request the registrar and transfer agent to send a form.

Can an investor make multiple nominations?

Yes! An investor may make up to three nominations and even specify the percentage of the amounts that will go to each nominee.

If the percentage is not specified, equal shares will go to the nominees.

Can a minor be a nominee?

Yes! A minor can be a nominee. However the guardian will have to be specified in the nomination form.

Can a nomination be changed?

A nomination can be changed and even cancelled. The relevant form should be filled and submitted to the Registrar or Mutual Fund Office.

If an investor has different schemes in a folio, will all units of all schemes be transferred to the nominee?

A nomination is at folio level and all units in the folio will be transferred to the nominee(s).

If an investor makes a further investment in the same folio, the nomination is applicable to the new units also.

Who can nominate and who is eligible to be a nominee?

Nominations can be made only by individuals applying for / holding units on their own behalf, singly or jointly.

Non-individuals, including societies, trusts, body corporates, partnership firms, the karta of an HUF, and the holder of a power of attorney (POA) cannot nominate.

Nomination can be in favour of individuals, including minors, the Central Government, State Government, a local authority, any person designated by virtue of his office or a religious or charitable trust.

A non-resident Indian can be a nominee, subject to the exchange control regulations in force from time to time.

Source: http://www.thehindubusinessline.com/iw/2010/10/10/stories/2010101051320800.htm

Long-term growth potential justifies high valuations

With over two decades of experience in the asset management, Sanjay Sinha, chief executive officer, L&T Mutual Fund, says when it comes to intangible products like mutual funds, people prefer to buy it offline through someone who can guide and provide service. In an interview with FE's Saikat Neogi, he says that in the medium to long term, more people will move to online purchases of mutual funds. Excerpts:

What explains the relatively high valuations of Indian equities? Does it signal an impending correction?

India’s long-term sustainable growth is likely to further increase the growth differential across markets. Global liquidity and the shift towards emerging markets have led to strong FII investments, leading to greater valuations of Indian equities. However, valuations are reasonable given the long-term growth expectations.

What would you advise retail investors now? Which sectors are you overweight or underweight?

The market looks attractive from a medium- to long-term perspective. While the recent run-has been is sharp and market might consolidate before moving ahead, we believe, equities are expected to perform well over the longer term. With India becoming one of the strongest growth countries, we expect companies to continue to do well. There may be sectoral variations, but therein lie the opportunities. We expect FII fund flows to continue. Hence, we advise retail investors not to get swayed by volatility if the objective is to gain in the medium to long term. Infrastructure, automobiles and cement sectors look attractive considering growth and valuation. With the recent rally in financial stocks, we believe they may consolidate in near term. We are underweight on telecom.

Globally, mutual funds are retail investors' avenue to invest in equities. Why has this trend failed to catch up in India?

In India, the mutual fund industry is still in its infancy. If you see its evolution, we are witnessing the fifth phase of growth. Investors like mutual funds to be sold to them rather than buy on their own initiative. The lack of equity culture and awareness are also deterrents. Investors still feel that mutual fund means stock market. Having said that, we should not understate the growth of mutual funds' retail assets. The industry is servicing almost 4.5 crore folios and attracting 45 lakh systematic investment contributions every month.

With rising household savings, do you see greater expansion in non-metros?

Mutual fund is a true savings product and has all the characteristics of an ideal investment product. It provides liquidity, tax-efficient returns, flexibility and ease of transaction. This makes mutual funds one of the best vehicles for an individual investor to route savings. Currently, investors are savers, parking money in bank deposits. As awareness grows, people will start searching for the right avenues which can give tax-efficient returns and returns above inflation. Non-metros are yet to see the reach of mutual fund companies in true sense. I am very bullish about mutual funds expanding in in non-metros.

After the ban on entry load, how will fund houses reduce the cost of MFs and attract investors?

After the ban on entry load, there is going to be a paradigm shift in product and sales and distribution strategy by fund houses. I feel three fundamental changes are going to happen. First, more and more transactions will become paperless. Fund house will promote online/web as a channel to attract retail investors. This will reduce the cost significantly and bring scale to overall distribution. Second, optimisation of resources is going to be a key differentiator. The resources may be of any kind. It can be in terms of time, manpower, de-duplication of administrative jobs etc. This can be made possible by the use of technology. Thirdly, fund houses will have to take collective efforts to graduate distributors to the next level by new ways of training/engagement/promotion and so and so forth.

How will the online model of selling mutual funds pan out?

People are beginning to fancy buying products offline. This is true for tangible products like white goods, food items, clothes etc. When it comes to intangible products like MFs, people currently prefer to buy them offline and that too through someone who can guide and provide service.

However, the change in demographic profile is bringing an online culture. Youngsters — potential savers of tomorrow — are quite fond of Twitter, Facebook and other such media. This clearly indicates the evolving atmosphere in the buying pattern of an individual. I feel in medium to long term, more and more people will gravitate towards buying mutual funds online.

Source: http://www.indianexpress.com/news/-Long-term-growth-potential-justifies-high-valuations-/694557

HDFC fund chief sees 20% return from market

Equities may return as much as 20% annually over the next three to five years, HDFC Asset Management chief investment officer Prashant Jain said. “Returns should be in line with earnings growth,” Jain, who oversees six of the 15 best-performing funds in the past decade, said. Earnings growth of 15% to 20% “from a diversified portfolio of equities is not very difficult to achieve,” he said.

The Bombay Stock Exchange (BSE) Sensex has rallied for a record seven straight quarters. The gauge has surged 18% this year as overseas investors bought a record $21 billion of equities on the expectation that surging consumer demand will boost corporate earnings even as global growth slows.

The Sensex has gained 28% from a May 25 low, approaching its record closing high of 20,873.33 on January 8, 2008.

Foreign fund inflows have surged 59% this year, according to data from the Securities and Exchange Board of India (Sebi) compiled by Bloomberg. Gross domestic product (GDP) expanded 8.8% in the June quarter from a year earlier, the most among major economies in Asia after China.

“India is clearly emerging as a key asset globally,” said Jain, who manages $21 billion in assets. “How many economies are there in the world which are of our size, growing at 8% to 9%, where neither the companies nor the households are leveraged?” The gains have made India the most expensive among the world’s 20 largest stock markets, according to data compiled by Bloomberg. Stocks on the Sensex are valued at 19.5 times earnings, compared with 13.7 times for Brazil’s Bovespa, 7.8 times for Russia’s Micex and 15.1 times for China’s Shanghai Composite, among the so-called Bric markets. “The markets are close to being fairly valued,” Jain said on Wednesday. “In three years, the economy and many companies have grown meaningfully. I don’t think it’s overvalued.”India stocks aren’t in a “bubble” territory even with the Sensex approaching its all-time high, BNP Paribas analysts led by Manishi Raychaudhuri wrote in a report on Wednesday.

Source: http://www.financialexpress.com/news/hdfc-fund-chief-sees-20-return-from-market/694120/

Funds turn open-ended, but investors stay on

Many investors now prefer to stay invested in close-ended funds that have just turned open-ended and are mobilising fresh investments from investors. Being mostly mid-cap funds, investors hope these schemes will fare well in the event of a further rally in mid- and small-cap stocks, say fund sellers.

About 10 close-ended schemes have turned open-ended over the past few months; almost all these funds are attracting money from investors. Among a handful of funds, Religare Mid-cap Fund, SBI Infrastructure Fund , Sundaram BNP Paribas Select Small-cap Fund, DSP Blackrock Micro-cap fund and Kotak Emerging Equity are attracting fresh money from retail investors.

According to mutual fund tracker Value Research, ING Optimix Multi-Manager Equity Option Scheme is the only equity scheme that got discontinued at end-of-term. Birla Sunlife Cash Plus Sweep Daily Dividend Fund and Fortis Overnight Institutional Plus Growth Plan are the only debt funds that got discontinued at term end. All the three funds had low asset bases, said fund researchers.

“A good number of these funds are flexicap funds with a mid- or small-cap bias. People invest in these funds on hopes that mid-cap funds will do well in a booming market,” said Hiren Dhakan, associate fund manager, Bonanza Portfolios. Interestingly, close-ended funds have not seen heavy redemptions, unlike most diversified open-ended equity schemes. Asset bases of funds like SBI Infrastructure Fund, HDFC Mid-cap Opportunities Fund , Religare Mid-cap and Kotak Emerging Equity have fallen only in the range of 11-22%. Usually, investors in close-ended funds prefer to redeem (or book profits) their entire investments at end of term.

“Most close-ended funds that got converted recently are 3-year-old schemes; these funds had raised and deployed NFO money when the markets were trading at record levels (in 2007). While these funds have logged decent one-year returns, they have not been able to outperform key indices on a 3-year basis,” said the marketing head of a corporate-promoted fund house, adding, “Investors are staying put in these funds as they don’t want to redeem their investments (of three years) at a loss.”

While existing investors remain invested in the fund for bettering their return profile, new investors are taking a sectoral or market-cap specific call. Themes like infrastructure and stock segments, like mid-caps and small-caps, are ‘flavours of the season’ among mutual fund investors. “Corpuses of these funds (that got converted to open-ended schemes) are fairly stable as there has not been much redemption or large inflows, post-conversion. Schemes with appealing themes and strategies are getting fresh investors,” said Lakshmi Iyer, head, fixed income & products, Kotak Mutual Fund .

Fund houses, on their part, are promoting these funds in a big way. They are paying upfront trail commission (for 2-3 years) to encourage distributors to sell these funds.

Source: http://economictimes.indiatimes.com/markets/stocks/market-news/Funds-turn-open-ended-but-investors-stay-on/articleshow/6695142.cms

We see financials as one of most promising sectors: Krishna Sanghvi

Krishna Sanghvi, Head of Equities, Kotak AMC in an exclusive interview with Harsha Jethmalani of Myiris.com, spoke about performance of his funds, FII inflow, sectors likely to emerge as star performers, etc.

Krishna Sanghvi joined the Kotak group in May 1997 in the Auto Finance subsidiary, Kotak Mahindra Primus, handling credit risk management. Post this; he moved on to Kotak Mahindra Old Mutual Life Insurance as an advisor to the Life insurance subsidiary, managing the debt and equity portfolios. He joined Kotak Mahindra AMC in February 2006 and has been handling equity schemes for Kotak Mutual fund since January 2007. He has over 13 years of experience in the financial markets of which 11 years are at Kotak Mahindra group.

Could you throw some light on the structure of your research team? What according to you goes into good portfolio construction?

We have a buy side research team with 8 research analysts and they cover more than 200 companies stocks across the sectors and across the market capitalization. Each analyst is tracking a sector(s) and stocks there in.

Portfolio construction involves a reasonable mix of sectors and stocks so that it offers diversification to investors and not make them exposed to individual themes / sectors / stocks. Portfolio construction considers the a healthy mix of some aggressive and some defensive stocks so that it generates returns and tries to minimize the downside risks.

How frequently do you churn portfolio for Kotak 30 Fund? The fund is betting on Financials, Energy, and Technology sectors what is outlook for these sectors?

We seek to manage the fund based on our views and outlook on markets and stocks and as such do not have any churn criteria.

We see financials as one of the most promising sectors in terms of growth in credit and earnings. A healthy economy growing at 8% will really provide this industry with the credit growth prospects of 20% and we still have a sizable population that needs to be covered under formal banking channels. Energy is again a promising sector led by de-regulation process announced by government as well as the view that considering global economic outlook (mainly USA & Europe) of a muted growth the crude oil is also likely to remain range bound. Technology is also interesting considering the offshoring opportunities available in western world.

How would you rate the performance of Kotak Opportunities Fund as against its peers? What is the highest individual stock and sector exposure you can take in this fund?

The fund has been performing reasonably well in terms of its track record vis a vis peers as well as the benchmark. The individual stock exposures are capped currently at 5% of the portfolios while sector exposures are capped currently at 25% of fund. We do review the limits based on the sector / stock weights in the underlying benchmark.

What is the general consensus on equity markets? Are money managers still underweight on equities now?

No we do not think money managers are underweight on Indian equities. The equity markets are clearly cheering the growth outlook for the Indian economy. The investor appetite especially of global investors has turned positive on relative growth for India as Indian economy is set to double in next 5-6 years. While valuations may appear a bit premium in near term, we believe that earnings growth will come in to support the valuations.

Market gains this year have been driven mainly by expanding PE multiples for stocks. Are you concerned that the market is too expensive today?

The PE expansion was bound to happen as a reaction to the PE contraction that was seen around 15-18 months back. While markets are getting into above average valuations zone, it is still lower than historic highs recorded on valuation perspective. Also, we think that valuations must be looked into with a forward perspective and on visibility of earnings growth and that`s where a comfort is in place that in the short term valuations may appear a bit premium but we believe that earnings growth will come in to support the valuations. We think the investor`s worry on Indian markets is mainly on account of markets having risen quickly in a reasonably short time.

Foreign fund houses have invested over Rs 710 billion (USD 15.6 billion) so far this year and analysts believe that FII investment in stock markets will cross the last year`s record level. What is your take on this?

We believe that investment flows usually reflect the investor`s faith in sustainability of GDP growth and earnings growth on a relative basis. At the current juncture of global economy. Indian economy - having demonstrated its resilience in past 2 years - ranks among the fastest growing economies in world. This has led to a reasonable investor attention and money; both short term as well as long term. We think this is quite healthy for the Indian economy and markets.

Given that mid and small-cap stocks are more sensitive to interest rates do you anticipate any slowdown in earnings due to increase in interest rate?

We do not anticipate any major impact on profitability due to increase in interest rates at present. The business growth can take care of interest costs. The only risk can be from any major hike in commodity prices that may impact the working capital and interest costs thereon.

What macro factors are you keeping an eye on?

GDP / IIP Growth, Fiscal Deficit, Current account deficit, inflation, interest rates, currency movements.

Source: http://www.myiris.com/shares/company/ceo/showDetailInt.php?filer=20101006153736707&sec=fm

Don't raise allocations just yet

This current rally has been completely driven by FII buying. Most domestic institutions have been net sellers or have cautiously sat on the sidelines. As a result, there has been a peculiar effect on mutual-fund returns.

In September, while the Nifty rose 11.5 per cent, other broad market indices also registered similar strong positive performances. But, according to a study by Value Research, 275 funds out of an universe of 303 actively diversified equity funds underperformed respective benchmark indices.

This means retail investors using the active mutual-fund route were ‘badly’ served by fund managers. There were a couple of important reasons for this poor showing. One was abundant caution. Many funds are carrying high cash allocations because they think current valuations are too high for comfort.

Another reason for the underperformance is the unbalanced nature of the rally. Large caps (the top 200 stocks) have outperformed smaller caps. Most actively diversified funds hold significant exposures to mid-caps. As a result, they underperformed benchmark large-cap indices. This is the flip side of active fund investing. Anybody who is invested in an active mutual fund is banking on the fund manager’s discretion. If the manager’s gut feel or investing model suggests the market is too highly valued, he should exit. Similarly, if his instincts suggest carrying a substantial corpus in smaller stocks, he must do so.

When the fund manager is right, he beats the benchmarks. When he’s wrong, he underperforms. Between 2005 and 2008, smaller stocks did outrun large-caps and this happened in 2009, as well. Similarly, as and when the market does peak, fund managers with high cash allocations save capital.

Should you be investing heavily at the current levels? Valuations are very high by historical standards. The domestic institutional attitude is negative. FII money is the sole driver and experience tells us that FII attitudes can change suddenly for reasons unconnected with the Indian economics.

Most Indian retail investors have been very cautious through 2009 and 2010 because most of them were burnt badly in the last (2008-09) bear market. One reason for the bearish DII stance has been the lack of retail inflows. However, there is every chance that surging prices will tempt retail investors to re-enter at 32-month highs.

This is a classic error retail investors are prone to. Retail investors usually buy at peaks, sell at lows, and ignore the market in-between, which is when they should be steadily accumulating. It’s probably related to the fact that media coverage of equity is always at its noisiest at peaks and lows.

My personal opinion: If you haven’t entered earlier, this is not a great time to increase allocations to the stock market. If you are already invested or thinking of investing, set tight stop losses and adhere to them.

Source: http://www.business-standard.com/india/news/don%5Ct-raiseallocations-just-yet/410468/