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Do you need multiple mutual funds to keep your money safe?

15 May 2022 - Contact Sayan Sircar
10 mins read

Given that mutual fund scams and issues are happening regularly, should you invest via many AMCs to ensure that you always have access to your money?

Do you need multiple mutual funds to keep your money safe?

Table of Contents

Post the allegations of front-running in Axis asset management company (AMC) in May 2022, many investors have a query if they need to spread out their money across different AMCs to minimise the impact of such AMC level issues. Apart from market risk, which makes the value of their investments go up and down, investors should also be aware of AMC risk and have a mitigation plan.

It should not happen that an important goal like children’s college education is due, money is stuck inside an AMC due to reasons beyond the investor or the market’s control.

What is the news?

Axis AMC in 2022

There have been allegations of front running on Axis AMC fund managers currently under investigation. Front running, which is not a new problem in India, is an illegal practice where someone buys stocks with the knowledge that someone else will buy those stocks in the future in large volume. The large volume purchase, which is expected as the day-to-day operations of an AMC with many equity funds and stocks held by those funds, drives up the stock price. The front-runner can then sell at a higher price and makes a profit. The reverse can be done when an AMC sells stocks.

How does this affect the investor: From an investor’s perspective, their funds bought stocks at a higher price/valuation, reducing future returns of the fund. All equity funds, active or passive/index or large/mid/small cap, have the potential of being affected.

Franklin Templeton AMC in 2020

In April 2020, Franklin Templeton stopped all inflow and redemptions transactions in six debt funds. The trigger was the drying up of debt markets due to COVID-19. Much of the investors’ funds have now been returned under SBI AMC’s process per SEBI’s requirement. However, this outcome was not known in April 2020, when Franklin froze the debt funds. This case was unique in India for multiple reasons and affected debt funds only.

How does this affect the investor: The investor lost access to the funds for an extended period. If the investor needed the funds for a particular goal, those funds had to be arranged from other sources. Given the standard recommendation of using short-duration debt funds, which was one of the affected funds, for short duration goals, the danger here is missing goals due to money getting locked up inside the fund.

Other forms of perceived risk

We present some more questions typically asked by investors and perceived as a risk along with these news items.

Is AMCs exiting India a risk?

There have been cases where AMCs, such as ING, Deutsche or JPMorgan, exited India. In such cases, as per SEBI rules, one of the following cases have happened:

  • their existing Indian partner has taken over the business, or the business has been sold to another AMC
  • the new AMC either runs the funds as their own after renaming them appropriately or merges them with their related funds

In any case, investors have been given the option, as per SEBI guidelines, to exit the fund without any exit load. But, of course, there will be capital gains tax in such cases since exit here means selling.

Investors should carefully evaluate two things before exiting, apart from the capital gains hit:

  • is the new fund, if merged, according to their requirements and goals. If yes, they should continue
  • if the fund is just renamed and continued under the new management, investors should continue if the investment mandate does not change and the expense ratio remains good post the takeover

Is AMCs getting taken over a risk for investors?

A related case is when AMCs sell their businesses to other parties, like the 2021 sale of Yes Mutual Fund to White Oak Capital, similar SEBI rules like partner exit apply. Therefore, investors should exit or continue the same manner as the section above on foreign partner exit.

In the worst case, if there are no buyers, the AMC will return the current value of the funds to the investor as a forced redemption.

Can an AMC run away with investor’s money?

An AMC is created by a sponsor company under the 1956 companies act and is regulated by SEBI. Along with SEBI, RBI has a role, specifically in foreign remittances and if the AMC is launching any guaranteed return schemes. All mutual funds in India follow the general best practices and code of conduct laid down by the Association of Mutual Funds in India (AMFI).

In theory, an AMC can run away with an investor’s money, but two things are expected to prevent that:

  • as per SEBI guidelines, the fund’s trustee oversees the investor’s interests so that all SEBI guidelines are followed, and the fund invests as per the written down investment mandate. SEBI rules require each fund to declare its portfolio monthly for equity funds and fortnightly for debt funds
  • the AMC will continue to earn income from the expense ratio irrespective of the fund’s performance. This is a more straightforward thing to do than running away

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What should investors do?

Active fund investors

Investors investing in active mutual funds should be mindful that they may not get a like-for-like replacement in another AMC. Also, there is the risk of diversifying across AMCs in an active fund category, like, say, mid or small-cap stocks, that the investor will end up investing across the entire market. Any alpha from one fund will be negated by a lack of alpha from the rest. The returns will be close to the index less the average expense of the funds, which is a poor outcome.

For example, let us say that there are three stocks in the market: A, B and C, with respective weights of 25%,45% and 30% in the index. An index fund is available at 0.1% TER. There are two active funds, X and Y, that track this index with 0.50% TER each. X has a portfolio of (20%, 30%, 50%) in A,B,C while Y has the portfolio of (30%, 60%, 10%).

A 50:50 holding in X and Y will allocate ((20+30)/2%, (30+60)/2%, (50+10/2%) or (25%,45%,30%) to A, B, and C, which is the same as that of the index, but the return will be lower by the 0.5% TER. At this point, the investor will be better off with the index fund at 0.1% TER.

Index investors

Passive funds, whether in equity or debt, are easier to diversify in terms of AMCs since the mandate is well defined. For example, a Nifty 50 index fund will give similar returns, irrespective of the AMC. There will be slight differences, which is the origin of the tracking error, due to the TER and internal processes of the AMC.

Here investing in index funds is like buying soap from a grocery store. There might be different colours, smells, and costs of varying soap brands, but at the end of the day, there is very little difference, apart from personal preference, between, say, Lux and Cinthol soaps. This fact allows easy diversification among AMCs for index funds. The funds in scope will be:

  • equity funds tracking large-cap indices like Sensex or Nifty 50
  • funds investing in constant maturity gilts like 10-year gilts or target maturity debt funds
  • money market and liquid funds, while not being index funds, strictly speaking, have a well-defined mandate of what type of bonds they can invest in

Index funds tracking smaller stocks will have significant tracking errors depending on the AMC and fund size. Therefore, they should be considered before diversifying across AMCs.

A practical series of steps to take for AMC diversification

Step 1: Decide on an AMC level threshold

This threshold defines limits that you will not cross in the amount invested per AMC. These could be absolute limits like ₹25 lakhs per AMC or, more practically, based on percentages like not more than 20% of the portfolio should be with a single AMC.

Step 2: choose index funds as much as possible

As discussed above, index funds offer an apple-for-apple replacement across AMCs. This is in line with our standard framework for choosing funds: Which funds should I invest in?

For active funds, check if other AMCs offer funds with similar portfolios and performance.

Step 3: Adjusting SIPs and lump sum

Once you have decided the AMC level split and identified the funds, then simply split future investments in that proportion. For example, if you are investing ₹30,000/month and have chosen 3 AMCs, then put ₹10,000 in each AMC/month. Any lump sum investments should be invested in the same way. Redemptions and SWPs, for when you need the money, should also be managed in the same way.

Step 4: Reducing operational risk

This step ensures that there are no operational issues that may cause delays in redemptions when needed. Such delays are caused by out of date KYC information or bank account details. One way to mitigate this issue is to perform periodic withdrawals of ₹1000 per AMC every six months or yearly to check if every detail is correct or not. You can set up a reminder using a calendar alarm or do this automatically via saved instructions in a platform like MFUtilities.

If a significant goal is coming up, always perform a test withdrawal of ₹1000/AMC a few months before.

Ultimately, it requires a level of faith while investing via financial intermediaries like AMCs. In many cases, there is a risk, but that risk may be small or manageable. Even investing directly in stocks may have risks like that seen with Karvy Stock Broking in 2021. Therefore investors should be aware and vigilant with their investments and keep an eye on related news flow.

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