Regulator Does Its Job, What About Fund Houses?

"The ethical is always more robust than the legal. Over time, it is the legal that should converge to the ethical, never the reverse," wrote Nassim Nicholas Taleb, author, Skin in the Game. The recent event in the domestic mutual fund industry shows that the reverse is happening and it is the legal that is forcing the fund houses to be ethical. It is the regulator that is interfering to set the house in order and introducing rules that should have been set and followed by the fund houses on their own in the interest of investors.

 In its recent meeting, the Securities and Exchange Board of India (SEBI) has introduced some far-reaching changes in debt mutual funds. For example, in the case of liquid funds, it has been mandated that the funds should hold at least 20% of their corpus in liquid assets, such as cash, government securities, T -bills and repo on government securities. Also, other changes were introduced pertaining to debt funds, keeping the investors' interest in mind. These changes were necessitated in the wake of recent credit events that have shaken the investors' confidence in debt mutual funds. One of the fund houses tried its best to gain confidence of the investors, but the effort was too late and too little.

The fund houses, in order to increase their assets under management (AUMs), invested in instruments that defeated the very purpose of investors' selection of that category of funds. An investor invests in debt funds not for higher returns, but for stable returns and liquidity. Some of the fund houses, however, invested in instruments such as structured obligations, which turned out to be more risky and hence not suitable for investment under such category. Moreover, once the beans were spilled, the fund houses chose to resolve the issue by means that suited them best and not by what was laid down by the law or what was in the best interest of the investors.

The steps taken by SEBI are likely to bring down the expected return of these categories of funds. Nonetheless, investors who invest in debt funds, liquidity and safety is far more important than the returns.