Investors in mutual funds have a lot of positives to look forward to. In the past three months, the Securities and Exchange Board of India has announced reforms that make MFs better investment vehicles and is working to curb mis-selling, too. A summary:
Dividends from profits: The accounting norm has been tweaked for dividends. This will result in fund houses having less for dividend payouts. The market regulator has ordered MFs to use only the realised profits to declare dividends in a scheme. Fund houses cannot use the unit premium account to pay out dividends.
An example. Assume an investor enters an existing scheme that has a net asset value (NAV) of Rs 18. For accounting purposes, an MF breaks this NAV into parts. Of the amount, Rs 10, the face value of the scheme, goes to an account called unit capital. The remaining Rs 8 goes to a separate account called a unit premium reserve.
Sebi has said the MF cannot use the money in the unit capital account, Rs 8 in the example, to pay dividends. Rather, dividends should be declared only when the NAV appreciates. In our example, say the NAV moves to Rs 20. Fund houses can only use Rs 2 to declare dividends.
Experts feel this step will curb MF mis-selling. "Agents have been pitching the dividends declared to mis-sell schemes. Many investors still don't realise that an MF dividend is different from dividends received on a stock. In an MF, an investor gets back his own money," said Manoj Kumar Vijai, executive director, KPMG.
"We will need to trade shares every time the dividend would need to be declared. Despite this drawback, there is no way we can look away from the fact that dividend payment itself is a much questioned practice," said the head of a fund house.
MF houses use this dividend to woo customers in its monthly equity-linked savings schemes and hybrid funds like monthly income plans.
Further, the regulator has directed the fund houses to mention the dividends in rupee terms, rather than a percentage of the face value. Funds usually declare dividends as a percentage to the face value, mostly Rs 10, of the scheme.
That's why dividends seem magnanimous when a scheme declares it. For example, if a fund declares a dividend of Rs 10, it means 100 per cent dividend.
Derivatives exposure: To make investors aware of the risk involved in a fund, Sebi has also mandated fund houses to declare their exposure in equity derivatives. Futures and options are risky and can lead to unlimited losses if the bets go wrong. This will force MFs to take lesser exposure to equity derivatives.
Sebi's Mutual Fund Advisory Committee has also proposed to cap the exposure of any scheme to derivatives at 100 per cent of its actual holding in stocks. This will not allow a fund house to excessively play in the futures and options market.
The requirement of only margin money in derivatives allows them to have a much higher exposure.
Making agents responsible: MFAC has also come up with recommendations that would make agents more responsible for their advice to investors.
The committee has proposed that agents categorise investors based on their risk profile, investment objective and affordability before selling funds. Among other recommendations, the committee suggested that distributors maintain written records of all recommendations and transactions.
The committee has also proposed that while advertising, fund houses should present the entire picture of the scheme's performance. This is because ads invariably talk only about the period in which a scheme had outperformed, not the reverse. The committee want funds to give both.
