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The Mutual Fund Show: How To Protect Your Investments During Volatility

Outflows from mutual fund schemes in December is not an aberration and the industry will face some challenges until the election, according to Vijay Mantri of JRL Capital.

However, investors waiting for an opportunity to enter the market should check the mutual fund schemes since units will now be available at lower price, Mantri, chief investment strategist founder promoter and chief mentor at the company, said in BloombergQuint’s weekly series The Mutual Fund Show.

Investors pulled out the most in three months from mutual funds last month led by an outflow from the money market schemes. Overall, the industry witnessed a net outflow of Rs 1.36 lakh crore compared with a net inflow of Rs 1.42 lakh crore in November, data released by the Association of Mutual Funds in India showed.

Mantri explained the governance structure and the regulatory restrictions to safeguard investors from any potential harm. Also, for those worried about the safety of returns and capital, he laid out a structural framework. “Investors should look at a trustee company rather an asset management company since the former holds the onerous responsibility of handling money, while an asset management company just manages the portfolio for its investors, who are the ultimate beneficiaries.”

Watch the full episode here:

Here are the edited excerpts of the interview:

Do you want to delve upon frameworks of mutual funds governed by SEBI as it is a three-tier structure? Why is it that this becomes so important?

In the past few months, there were question marks on sponsor of some mutual funds. There are some fund houses where there was a run on stocks of sponsors and concern on balance sheet of the sponsor of mutual funds. So, people start asking questions that they have invested in a sponsor’s fund house and if the sponsor has some problem does it transfer problem for mutual fund portfolio as well.

The regulator has ring-fenced mutual fund investors from whatever is happening to the sponsor. For that we need to understand the structure of the mutual fund.

First is the screening criteria. Anyone who wants to become a sponsor of mutual fund needs to have a sound track record in the financial services industry. If somebody has a track record in manufacturing industry, he cannot become a sponsor. They need to have a positive net worth in last five years. They should be profitable.

After that the sponsor sets up the asset management company and the trustee company. We have seen asset management company most of the time because it is the face of mutual fund and that entity manages the money for investors. A trustee company is more important for investors.

There is an interesting regulation for the trustee company. Anybody who wanted to be appointed on the board of a trustee company, then those members’ names have to be cleared by the regulator. Trustee hold assets in custody for investors they manage the scheme.

The mutual fund is a distinct body and therefore will not get impacted. The units are held by the individual person.

Absolutely. The trustee has onerous responsibility on it. When you invest in mutual funds, you subscribe to unit of a trust. The owner is trustee company, but the beneficial owners are mutual fund unit holders. So, the money belongs to you.

Why is it important to have knowledge about restrictions in mutual funds?

When you subscribe to any mutual fund option or product, mutual fund needs to give liquidity, except ELSS where there is three-year lock-in period, or you have closed-end funds like FMP (fixed maturity plans). In rest of the product, mutual fund needs to give exit window which means they can only invest in tradeable securities. First, mutual funds can’t give loans. When you give loan, it is an agreement between two parties. You don’t know what terms and conditions you sign. You can do any kind of deal. In mutual funds, you can only invest in tradeable securities and listed securities. So, there is a restriction.

Mutual fund is not allowed to have a concentration of portfolio in a few stocks. Regulators make it very clear. When it comes to equity-oriented mutual funds, the maximum it can invest in a single stock is 10 percent. Several mutual fund houses most of the time have much lower exposure to a single stock. The portfolio is very well diversified and the portfolio is always very liquid.

Second, how does it deal with group companies. There is a clear restriction on how much one could invest in group companies. Any AMC or mutual fund scheme cannot invest private placement of securities of group companies. They can only subscribe in the public platform. A 10 percent rule applies and maximum you can go up to 25 percent in group companies. So, there are restrictions put in by the regulator. The mutual fund doesn’t have a concentrated portfolio. Mutual fund serves the purpose of what they are set up for, which is to serve the large public and create a liquid portfolio.

We don’t know of too many funds or schemes which have exposure of more than 10 percent to a single stock.

If you go by 10 percent, the mutual fund can have 10 stocks. But no mutual fund has 10 stocks. Even focussed funds have 25 stocks. Most of the funds will have 50-60 stocks in portfolio.

There is one critical thing which differs mutual fund from other products. Suppose a debt scheme wants to introduce equity component, it has to intimate existing investors. It has to give them exit window of whether you agree with that terms and conditions and if they don’t agree then there is 30-day exit window available to you where you can take your money out without any exit load. When you subscribe to a scheme of mutual fund, whatever be the terms and conditions, these cannot be changed at your disadvantage going forward, whether there is entry or exit load. It’s there when you sign the mutual fund.

When you invest in a bank, you don’t know where the bank is lending the money. When you invest in property, they show you the sample flat, but you don’t know the final outlook. Mutual funds are the only products where you can see existing portfolio which say this is how they have invested in stocks or securities and you can take a call whether to invest or not. That information comes to you every month. The kind of transparency mutual fund industry has, I don’t think any other financial services product offers.