Tougher Rules For Mutual Funds Mean Volatile Returns, Higher Safety

The market regulator tightened norms for mutual funds after some of the debt investments by asset managers put investor money at risk.

Exposure to debt and money-market instruments will be marked-to-market against the earlier practice of amortisation, according to a statement by the Securities and Exchange Board of India after its board meeting. SEBI lowered the sectoral cap and allowed fresh investments only in listed non-convertible debentures and commercial paper, and equities.

Stricter norms come after a spate of credit-related events, starting with the defaults by IL&FS group last September, which forced asset managers to write off their investments. Troubles of Essel Group, Dewan Housing Finance Ltd. and Anil Ambani group companies only amplified worries about debt schemes.

That forced the regulator to take measures to restore confidence and safeguard investor interest. Here are the key changes and their impact:

Change In Valuation Method

Mutual funds will have to mark to market their investments in debt and money-market instruments. The regulator dispensed with valuations based on amortisation.

Impact: Kaustubh Belapurkar, director-fund research at Morningstar, said it will bring higher volatility in returns.

No To Standstill Pacts

Ajay Tyagi, chairman of SEBI, said at a press conference after the board meet, “Mutual funds are not banks, so there’s nothing called standstill. They are investing, not lending.” There has to be more discipline and prudence in the industry to protect investor’s money, he said.
Impact: If you believe that investors are best served by entering into a standstill agreement or side-pocketing, so be it, said Amit Tandon, managing direct proxy advisory firm IiAS said. What SEBI has done is that it has removed the element of judgment or discretion away from the hands of the fund managers.

Lower Sectoral Limit

Mutual funds can only have 20 percent exposure to one sector in a scheme, down from 25 percent earlier.

Moreover, the 15 percent cap for investments in housing finance companies has been split—10 percent for mortgage lenders and 5 percent for debt securities based on retail housing and affordable housing loan portfolios.

Impact: The decision will reduce the sectoral risk to that extent, said Amol Joshi, founder, PlanRupee Investment Services.

20% In Liquid Assets

SEBI mandated liquid funds to hold 20 percent holdings in liquid assets.

Impact: While the move would lead to lower returns, it would ensure safety of portfolio, said Joshi and Belapurkar.

Fee For Exiting Within Seven Days

SEBI has levied a graded exit load on investors of liquid schemes who redeem with seven days of making an investment. This is similar to the loads imposed in certain schemes to prevent entry of hot money for quick gains.

Impact: Seven days is a relatively short term and will not impact retail investors who typically use it for a few weeks to a few months for parking funds, said Rajeev Thakkar, chief investment officer at PPFAS Mutual Fund. But corporate funds will now move to overnight funds, he said.

Investments Only In Listed Securities

All fresh investments by mutual funds schemes to be made in listed commercial paper, equities and non-convertible debentures. SEBI also mandated an adequate safety cover of at least four times for investments in debt securities with credit enhancements backed by equities—directly or indirectly.

Impact: On the face of it, the decision will definitely reduce the dependence on credit rating agencies and make it more market driven, said financial planner Harshvardhan Roongta. Investors will get a more realistic valuation for their investments in liquid funds, he said.

Watch video

For all other key takeaways from the SEBI board meet click here.