Skin in the Game: Impact of the New Mutual Fund Regulation
The Indian Mutual Fund industry manages over INR 32 lakh crores across 9.86 crores accounts or folios(as on 30th April, 2021), counting not only retail investors among the unit-holders (investors), but also HNIs and large institutions (primarily in liquid, money-market and overnight funds, which are relatively safer debt funds, but also offering lower returns due to their conservative investment strategies).
All these investments are spread across the different schemes of the Mutual Funds, and each scheme has a fund manager responsible for the investment decision. The fund manager is supported by a research team (helping in the decision making) and a dealing team (helping in the execution). These fund managers report to the Chief Investment Officer(s) (who can also be managing some funds of their own), who in-turn report to the Chief Executive Officer.
Apart from the investment team, a Mutual Fund house also has a sales team led by the Head of Sales (the designation may vary for different fund houses) and a compliance officer, who is responsible for ensuring the process followed in the fund management is in line with the guidelines set by the Securities and Exchange Board of India (the agency responsible for regulating the Mutual Fund industry in India), the Association of Mutual Funds in India (AMFI — the Trade Body of the Indian Mutual Funds) and the trustees of each Mutual Fund house. Additionally, there are also other support functions like the CFO, Head of Operations, Head of IT, Head HR and Company Secretary etc.
All these people work in tandem to ensure that they generate returns which are higher than the market indices. With the responsibility of not only managing a large corpus of public money but also beating the market, the complex structure of a mutual fund house makes sense. After all, an investor entrusts the fund manager the decision making authority with the expectation of deliver better risk-adjusted returns.
However, the situation becomes a bit complex when the fund managers not only are unable to beat the market/indices, but also generate permanently negative returns. While this may sound highly unlikely, it has happened with many credit risk funds — a category of high-risk debt funds — due to many investments made by the fund managers failing, including some marquee names in the industry like IL&FS, DHFL and Cox & Kings.
While some may argue that the investment in mutual funds come with their own fair share of risk, it can also not be denied that some Mutual Funds were affected significantly more than the others, with the likes of ICICI Prudential MF not seeing a single default in their debt funds. This hence puts the investment style of the fund houses affected more into question, where they may have been taking unnecessary risks in their attempt to generate comparatively higher returns, and retail investors getting attracted to the short-term returns of these funds without completely understanding the higher long-term risks sitting in their books.
To tackle this, and also to incentivize the fund managers and everyone else mentioned above perform better at whatever they do, SEBI has come out with a new regulation which mandates everyone mentioned in the earlier paragraphs getting 20% of their salary post-deductions like tax and statutory contributions like provident fund in the units of the funds that are managed by them.
For fund-managers, this regulation is straight-forward: 50% of the 20% investment will be made in the scheme(s) being managed by the fund manager themselves, and the remaining 50% can be invested in fund which is of higher risk category than the one they are managing.
The real complexity comes into the picture with the investments to be made of employees like the CEO, CIO, Head of Sales and the Dealing team, who are not responsible for the management of any specific fund. In their case, the entire investment will be divided in all the funds that exist, pro-rata to the total money that is already being managed in that fund. These investments will be locked-in for a period of 3 years, post which the employees will be free to remove the investments made.
On the face of it, this regulation seems understandable. Employee Stock Options (ESOPs) function in a similar manner: as they work to make sure that the company performs better, the price of the stocks go up and the holders of these stock-options benefit. Similarly, as the fund-manager performs better, the returns generated by these investments go up, and not only do these fund-managers and other employees benefit, but also do the retail investors in these schemes.
However, only when we go deeper do we realise that it is a lot more complex than that. The management of the personal money of the likes of the CEOs and the Heads of Sales — which may end up being across over 100 funds, with some companies managing money across as many funds — will be significantly more difficult.
Additionally, not every employee included in the list released by SEBI is as well-paid, and a hit of 20% on their net-income can lead to put a significant dent on their disposable income. During a session on Twitter spaces, it was pointed out by one of the speakers that for someone like in the dealing function who may not be earning as much, and may have commitments like home-loans (EMIs in some cases can be as high as 40% of their monthly net-income) as well, and an income post tax, statutory deductions, home-loan EMIs and now the mandatory investments, the existing pay may just not be sustainable.
Thirdly, This can also lead to a drain of talent from the mutual fund industry to other industries like insurance (who also actively look at hiring investment and support professionals) and also Portfolio-Management Services and Hedge Funds, who can afford to pay higher than the mutual fund houses due to lesser transparency and leaner organization structures.
If the fund-houses are not able to retain the fund managers and the support staff, the drain of the talent can also in-turn impact the investors, with the quality fund-managers moving into the other industries which would not only give them a better pay-package but also more flexibility in terms of the management of their respective funds.
To tackle this, the fund-house may increase the salary of at least the lesser paid employees. However, at the sake of the investors, this will lead to the shareholders of the companies suffering (albeit not a lot), with the costs of the company increasing, and hence impacting the profitability.
This move has seen a mix response from the industry. Radhika Gupta, the MD and CEO of Edelweiss Mutual Fund, came out strongly and criticized the regulation in a series of tweets. She then called for the simplification of the regulation in an article she authored for the mint. Additionally, Jimmy Patel, MD and CEO of Quantum Mutual Fund, also came out strongly against the regulation, calling it arbitrary and illogical.
On the other hand, other leaders like A Balasubramanian, MD and CEO of Aditya Birla Sun Life Mutual Fund and Kalpen Parekh (during the Twitter Spaces session mentioned above), President of DSP Mutual Fund, have come out in support of these guidelines, which, in the end, should not only benefit the smaller investors, but also attract more people towards mutual fund investments.
This has hence led to a debate across the industry, with many feeling that at least people like the Head-HR and the Head of Information Technology, who have no control on the investment decisions anyways, and people who have relatively lower income like those in the dealing teams, should be left out of the purview of the regulation.
While the Mutual Fund houses are expected to approach SEBI with a request to reconsider, if they haven’t already, it is unlikely that SEBI will bulge on this regulation, with the regulator taking multiple decisions lately to protect the interest of the investors.
Disclaimer: The views expressed in this article are personal, and are not to be associated with the organisations we are a part of.
