New investment products by mutual funds open doors of opportunity

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Let me take this opportunity to wish you and your family a very Happy Navratri!!

The financial market regulator Securities & Exchange Board of India (SEBI) has announced the introduction of a regulatory framework for a new investment product or new asset class (NAC). This is a move in the right direction. These sophisticated products are a win-win for both mutual fund houses as well as investors.

Before getting into the benefits of the regulatory framework for NAC, first let’s us understand why these products are required:

Mutual fund schemes have been around for more than three decades. They have evolved and become transparent and cost-efficient over a period of time. In October 2017, the SEBI announced norms pertaining to categorisation of mutual fund schemes. Post 2020, the regulator also announced a slew of measures to contain risks in existing mutual fund schemes, as well as put in place indicators for investors to understand the risks they are exposed to. These include risk-o-meter and potential risk class matrix.

Along with the evolution of mutual funds, investors also matured and asked for newer solutions to cater to specific needs. We have seen a growing market for portfolio management schemes, alternate investment funds (AIF) and regulated ‘stock-basket’ services. The threshold for PMS is kept at Rs 50 lakh and for AIF it is set at Rs 1 crore. As the mass-affluent segment of the investment public increases there emerges a need for sophisticated investment strategies. However, these investors find it difficult to cut a cheque for PMS or for AIF. This has paved the way for shenanigans offering unregulated portfolio advisory services. We have read many news items pertaining to how investors are duped by such unregulated actors.

In this backdrop, it is required to offer products that are sophisticated and serve the needs of matured investors. Minimum ticket size of Rs 10 lakh for NAC is a reasonable starting point and should attract a sizable chunk of money by even high networth individuals (HNI).

Strategies such as long-short equity investing, reverse indexing may find many takers in India. Importantly, when these are executed by professionals in mutual funds, investors are likely to experience better risk management. Though the regulator has unveiled the guidelines recently, the mutual funds are yet to come out with product ideas.

Investors in PMS and stock-basket services are also eagerly waiting for these products. After the increase in rate of tax on capital gains – both long and short term, the post-tax returns on PMS, stock-basket services are expected to moderate, other things remaining the same. These arrangements hold the stocks in the name of the investor and each transaction may attract tax-liability. For high churn strategies, involving frequent buying and selling of shares, investors end up paying a large chunk of gains in taxes. Remember, the short-term capital gains on equities are taxed at 20%.

Mutual funds however, are pass-through vehicles. Fund managers of MF schemes do not pay tax on profits booked. The tax liability crystallises for a mutual fund investor only when the investor sells units held. If mutual funds are allowed to offer sophisticated investment strategies, which are being used by PMS, then investors looking for tax-efficient returns may shift to these NAC.

Structured institutional approach of mutual funds is also supportive for sophisticated strategies. Mutual funds can invest significantly in risk-management systems, technology infrastructure and professionals to ensure that the investment outcomes are consistent over a long period of time. This may not be possible for all PMS providers due to want of capital or lack of management depth. Mutual funds are tightly regulated products and the NAV based approach offering one portfolio for all investors ensures transparency. PMS and stock-basket services usually face execution challenges and accordingly the investment outcomes differ.

Many investors hence may prefer to invest in NAC. These products are not aimed at solely generating higher returns. Mutual funds can also offer strategies that can reduce the risk. It will be interesting to see how mutual funds respond to the evolving needs of the investors.

These products are targeted at evolved investors. In other words, first-time investors and beginners may need some hand-holding. They have to understand the offering in addition to investing the minimum Rs 10 lakh in each scheme. For all those who find it difficult to achieve this, there is no reason to lose heart. They can still invest in diversified equity schemes such as flexi-cap and multi-cap schemes or multi-asset funds using systematic investment plans. These products also can help investors to fund their financial goals such as child’s education or retirement.?

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Disclaimer: This report is prepared in his personal capacity and neither the Author nor Money Honey Financial Services Pvt Ltd assumes any responsibility or liability for any error or omission in the content of the article. Investments in mutual funds and other risky assets are subject to market risks. Please seek advice from an investment professional before investing.

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