Entities Involved in Mutual Fund Part 1

Regulatory Authorities: To protect the interest of the investors, SEBI formulates policies and regulates the mutual funds. It notified regulations in 1993 (fully revised in 1996) and issues guidelines from time to time. MF either promoted by public or by private sector entities including one promoted by foreign entities is governed by these Regulations. 

SEBI approved Asset Management Company (AMC) manages the funds by making investments in various types of securities. Custodian, registered with SEBI, holds the securities of various schemes of the fund in its custody.

According to SEBI Regulations, two thirds of the directors of Trustee Company or board of trustees must be independent. The Association of Mutual Funds in India (AMFI) reassures the investors in units of mutual funds that the mutual funds function within the strict regulatory framework. Its objective is to increase public awareness of the mutual fund industry. AMFI also is engaged in upgrading professional standards and in promoting best industry practices in diverse areas such as valuation, disclosure, transparency etc.
  
The SEBI regulations stipulate that a mutual fund should be structured in such a way as to ensure clear differentiation between the promoters and managers of a fund. The various functionaries as defined in the regulations and required for any mutual fund are:

Investors : Every investor, given Investor’s financial position and personal disposition, has a certain inclination to take risk (risk profile / risk appetite).  The hypothesis is that by taking an incremental risk (of losing capital, wholly or partly), it would be possible for the investor to earn an incremental return. But assuming risk without regularly monitoring it is foolhardy.  Therefore, it would be prudent for investors who take a risk to be able to manage this risk. MF is a solution for investors who lack the time, the inclination or the skills to actively manage their investment risk in individual securities.  They can delegate this role to the MF, while retaining the right and the obligation to monitor their investments in the scheme (which, in turn, invests in individual securities).In the absence of a MF option, the moneys of such “passive” investors would lie either in bank deposits or other “safe” investment options, thus depriving the investors of the possibility of earning a better return.

 

Investing through a MF would make economic sense for an investor if Investor’s investment, over the medium to long term, fetches a return (net of all costs and expenses) that is higher than what Investor would otherwise have earned by investing directly. Because the goal of investing is to accumulate real wealth – an enhanced ability to pay for goods and services – the ultimate focus of the long-term investor must be on real, not nominal, returns. 

The Fund Sponsor : The trustees have a critical role to play as they are directly responsible to the investors/unit holders in the mutual fund. The trustees in turn appoint the asset management company (AMC). The AMC conducts the business of managing the day-to-day administration and fund management activities as also marketing and sales.

It is apparent from the above 3-tier structure that the sponsor has little or no role to play in direct fund management. From the investor's perspective investor’s mutual fund schemes are managed by the AMC, which is run professionally and has a Board of Trustee to report to.

The sponsor is required to contribute at least 40% of the minimum net worth (Rs. 10 crore) of the Asset Management Company and posses the sound track record over the last five years prior to registration. The board of trustees manages the MF and the sponsor executes the trust deeds in favor of the trustees. It is the job of the MF trustees to see that schemes floated and managed by the AMC appointed by the trustees are in accordance with the trust deed and SEBI guidelines.

This is quite unlike a corporate structure where the promoter  in most cases is directly involved and responsible for the day-to-day functioning of the company. Therefore the stock price is directly related to the events affecting the promoter.

The experience and track record of the sponsors should be such as to give confidence to potential investors. Their reputation for investor friendliness, transparency, regulatory compliances, etc should be verified in detail. The offer document would contain details of all regulatory actions and investigations against the sponsors within the country and abroad. They should be studied in detail to understand the seriousness of the alleged offences. The possible financial impact of adverse regulatory rulings on the sponsors should also be understood.

Promoters or sponsors of the fund are not allowed to influence the investment decisions of the fund. Once the fund is operational, they are expected to retreat to the background and let the fund managers handle the operations of the fund. However, they appoint the fund managers and are responsible for ensuring that the fund management is carried out in the best interests of the investors with complete integrity and transparency.

If the sponsor or one of the sponsors is a foreign entity, the reputation and track record in its home country should be studied. Many of the prominent foreign fund managers operating in Indiaare well reputed globally and each of them has its own distinct investment philosophy. It is advisable to see if their fund management philosophy matches investor’s outlook and requirement.

Financial performance of the sponsors for the previous three years would be provided in the offer document. Consistently good financial performance over the years would be a good indicator to the capabilities of the sponsor.