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?
Table of Contents
- What is the news?
- Other forms of perceived risk
- What should investors do?
- A practical series of steps to take for AMC diversification
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
Our new Goal-based investing tool will help you to create and manage all of your goals in one place. Click the image below to get access:
Arthgyaan creates a system for reaching your financial goals by sharing simple, actionable advice backed by research and analysis.
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.
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.If you liked this article, consider subscribing to new posts by email by filling the form below.
Previous and Next articles:
What should you do when both stocks and bonds fall?
This article talks about the steps to take in the current market scenario when stocks and bonds are falling simultaneously.
Published: 8 May 2022
5 MIN READ
Frequently asked questions on Sovereign Gold Bonds (SGB): the complete guide
This article compiles an exhaustive list of FAQs for Sovereign Gold Bonds (SGB).
Published: 18 May 2022
1 MIN READ
How to use the Cost Inflation index (CII): latest value and historical rates
This article shows the latest as well CII value and shows you how to use it for calculating capital gains tax.
Published: 29 June 2022
2 MIN READ
Asset allocation for NPS: equity or debt / active or auto?
This article provides guidance on choosing the right combination of equity and debt along with allocation plan for NPS subscribers.
Published: 22 June 2022
6 MIN READ
Topics you will like:Asset Allocation (18) Basics (5) Behaviour (10) Budgeting (9) Calculator (10) Children (6) Choosing Investments (24) FAQ (2) FIRE (8) Gold (6) House Purchase (10) Insurance (6) Life Stages (2) Loans (10) NPS (3) NRI (3) News (5) Portfolio Construction (27) Portfolio Review (17) Retirement (20) Review (7) Risk (6) Set Goals (24) Step by step (3) Tax (10)
1. Email me with any questions.2. Use our goal-based investing template to prepare a financial plan for yourself
use this quick and fast online calculator to find out the SIP amount and asset allocation for your goals.
Disclaimer: Content on this site is for educational purpose only and is not financial advice. Nothing on this site should be construed as an offer or recommendation to buy/sell any financial product or service. Please consult a registered investment advisor before making any investments.
This post titled Do you need multiple mutual funds to keep your money safe? first appeared on 15 May 2022 at https://arthgyaan.com
We are currently at 161 posts and growing fast. Search this site: Copyright © 2021-2022 Arthgyaan.com. All rights reserved.