Small mutual funds protest Sebi move to hike networth

The little guys among asset management companies (AMCs) have lambasted a proposal to increase the minimum networth of mutual funds in representations made to the Securities and Exchange Board of India (Sebi); variously describing argument in favour of doing so as ‘spurious’ and ‘intellectually bankrupt’.

Benchmark, Parag Parikh Financial Advisory Services and Quantum Mutual Fund are among the fund houses who have written to the market regulator over the last two weeks on the recommendations. They have suggested that networth is of little consequence for AMCs and increasing the minimum requirement could be detrimental to mutual funds’ market penetration.

A Sebi sub-committee had drawn up the proposals to hike the minimum net worth for asset management companies to Rs 50 crore from Rs 10 crore now.  The Sebi had made the recommendations public on May 13 and invited feedback up to June 14.

Increasing the net worth would create artificial barriers to entering the mutual fund business suggests Rajan Mehta, Executive Director at Benchmark Asset Management Company. “If people are forced to bring in additional capital then the return on equity expectation goes up, and low-priced products are not an attractive proposition from the perspective of shareholders. This would be detrimental to investor interests,” he said.

The infrastructure requirements too do not add up to a large amount, with many functions such as custodian services and research being outsourced to third-party service providers, suggested some of the AMCs.

“The decision on infrastructure is left to the AMC and its trustees. Sebi further ensures that infrastructure is adequate by carrying out an inspection before granting final approval. The arguments are spurious,” said Parag Parikh, chairman of Parag Parikh Financial Advisory Services, which has an application for starting an AMC pending with the regulator. Asset management firms have also argued that they are unlike banks, who have to pay their depositors and insurance companies who are obliged to pay people who have taken policies.

In the case of mutual funds, the trustees appoint the AMC merely as a service provider. “The argument is intellectually bankrupt. It is like asking a chartered accountant or doctor to have a very high networth. Sebi should accept those recommendations which give investors a wider choice, not those which give investors fewer choices” said Ajit Dayal, Director of Quantum Mutual Fund, who has sent his recommendations to Sebi over the issue.

Interestingly, another sub-committee suggested that the minimum networth for AMCs be kept the same. The original committee suggested implementing the hike in a phased manner over three years. This would help to put in place minimum infrastructure, help ensure sustainability of the business and provide a means of accessing greater liquidity in times of market stress.

After the collapse of the Lehman Brothers in October, redemption pressure had forced a liquidity crisis among asset management companies.

However, if an AMC’s networth is to be used as a means of dealing with illiquid investments, it negates their nature as pass-through vehicles where market risk is borne by the investor, suggested those who had written against the move.

“You should not create the notion of guaranteed returns because then you are creating another UTI,” said one individual, talking of the days of guaranteed returns in the Unit Trust of India’s US-64 scheme and its eventual collapse.

Industry observers too suggest that the move could reduce competition. “Enhancing the networth is like enhancing the bar for new entrants, thereby making the industry less competitive. Capital should not be an impediment to entry. If at all, the networth should in proportion to the size of assets under management instead of keeping it the same for everyone,” said Dhirendra Kumar, CEO, Value Research, a mutual fund rating agency.

Questions have also been raised, informally, drawing attention to the fact that only large AMCs had been part of the sub-group, which drew up the recommendations. Raising the networth would help to create a closed club of large AMCs and could act as a means of  reducing competition in an industry already affected by falling profits due to their inability to give distributors the same kind of commission as offered by products from rival industries, said an industry insider. An email sent to Roopa Kudva, the head of the sub-committee received an ‘out-of-office’ reply. One sub-committee member declined comment while another did not respond to an email questionnaire.