A Capital Crime: the myth of minimum net worth

22 MAY 2010

Just as you thought the mutual fund industry (or those that dominated it for the past decade) would have finally learned to focus on what is good for the investor, comes a last gasp attempt to perpetuate a business model that has stunted the growth of the mutual fund industry and worked against the interest of the investors.

For over 15 years the Association of Mutual Funds in India (AMFI) and its constituents have been silent on the terrible business practices adopted by many in the mutual fund industry. The mutual fund industry has had one single objective: go out and gather assets.

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Free trips to Mauritius, Singapore, and Europe were the norm as fund houses "incentivised" distributors to raise assets. Cars, clothing, and other gifts determined which mutual fund was "sold" to the innocent public. The private sector banks, brokers, and specialised national distribution houses all jumped onto the bandwagon and collected their fees. Whether the fund they sold to you was good for you or not, was not material.

Myths were created and ratified by the silence of AMFI, an industry body that represents the interests of the mutual fund industry - not necessarily the interests of the investors. Some of them:

  • dividends are good for investors (really?)
  • thematic and sector funds are not that risky (hogwash!)
  • the larger AMCs will have better performance - and are safer (hmm, who needed a bail out from the government of India in the year 2000 and which mutual funds’ FMP schemes had to be saved by the RBI after the collapse of Lehman Brothers in September 2008?)
SEBI has stepped in to stop the questionable practices on the distribution front and improving the practices of the mutual fund industry.

As of August 1, 2009 SEBI has banned mutual fund houses from paying front end fees that were lavishly distributed by the mutual funds from your wallet - without you even knowing about it! But that did not make any difference to Quantum Mutual Fund, a fund house with which I am associated.

Shocked by this malpractice adopted by even some of the well respected business houses in the mutual fund business, (arey, baba, everyone does it, so how can we fight it?) Quantum Mutual Fund adopted a direct-to-investor approach of "gathering assets". Our rationale: we did not wish to adopt a dishonest and opaque business practice that added to your cost as an investor. We went this direct route in March 2006 with the launch of the Quantum Long Term Equity Fund. That was 3 years before the SEBI ruling made it an industry practice.

Yes, Quantum Mutual Fund, was the first - and still the only - mutual fund house to focus on what is best for your costing by refusing to pay the "distribution rate card" that ruled the industry. Our reward? Knowing that we are doing the right thing and working in your interest. Our AuM is just about Rs 100 crore across our 6 mutual fund products. No distributor will recommend our funds to you. But, as we build a limited and sensible range of investment products that perform over time - without taking undue risks - we are sure that you will listen less to your distributor and more to us. Many distributors and financial planners are, indeed, good at their work and honest in their recommendations to you: they will evaluate Quantum Mutual Funds on a professional basis. Not based on cars and free trips to Singapore.

Yes, this ant walks tall among the herd of elephants.

The ant swatter strikes.
To be fair, AMFI has a new CEO and some in the industry now recognise the need to adopt a business model that works for the investors, not against their long term interests. Like Quantum, this group is ready and willing to take on the insurance industry as it goes about dumping ULIPs onto your lap. (By the way, have you noticed how your neighbourhood distributor or private bank advisor has stopped selling you mutual funds since August 2009 and now spins you a wonderful story on ULIPs? That is no coincidence: ULIPs pay a higher commission - from your pocket, of course!)

But while the mutual fund industry re-groups around a new set of ethics and business practices, a SEBI-appointed sub-group to look into the eligibility norms for setting up (and maintaining) a mutual fund business have come out with a swatter to knock off all us ants, cockroaches, and other irritants that threaten the regime of the elephants.

So, while SEBI is trying to clean up the industry and ensure that the rogue elephants are sent packing, the sub-group wants to extinguish the ants.

In 1993, one needed to have a Rs 3 crore net worth to set up a mutual fund business. Now it takes a net worth of Rs 10 crore. The sub-group wants to raise this minimum net worth to Rs. 50 crore.

Table 1: Hi, Doctor, how rich are you?

Name of the AMC, mutual fund houseQuantumRelianceBirla Sun LifeFidelityHDFCFranklin Templeton
Year ending data available 30-Jun-09 31-Mar-09 31-Mar-09 31-Mar-09 31-Mar-09 30-Sep-09
Net worth (Rs cr) 12.08 842.33 92.08 49.55 284.64 321.03
AuM, March 2010 (Rs cr) 102.67 111,819.33 69,531.84 7,795.22 94,702.79 34,911.90
Net Worth / AuM (%) 11.77% 0.75% 0.13% 0.64% 0.30% 0.92%
Source; SEBI, web sites

The sub-group was headed by Ms Roopa Kudva, MD & CEO, Crisil. The otherMembers of the sub group were:

  • Mrs. Chitra Ramakrishan, DMD, NSE - a stock exchange
  • Shri S. H. Bhojani, Sr. Partner, Amarchand Mangaldas - a law firm
  • Shri Paresh Sukthankar, ED, HDFC Bank - a bank with a distribution business
  • Shri A. Balasubramanian, CIO, Birla Sun Life AMC Ltd - a large AMC
  • Shri Sanjay Shah, MD, Morgan Stanley India Securities Pvt. Ltd. - a broking house,
  • Shri Milind Barve, MD, HDFC AMC Ltd. - a large AMC
  • Shri Nilesh Shah, DMD, ICICI Prudential AMC Limited - a large AMC
In their questionable recommendation, the sub-group members note that capital is not really a significant factor in determining who gets - or does not get - a license to manage money in Singapore, UK, Europe, and USA.

They also recognise that the "operations of the AMCs are in the nature of a pass through". In plain English what this means is that, as a fund manager, Quantum Asset Management Company Private Limited does not any time own the shares that it buys.

The money in the Quantum Mutual Fund belong to you, the investors; and the shares, gold, or government bonds in the Fund all belong to you. The fund managers only decide where to put your money, how much to buy, how much to sell, when to buy, when to sell. At no point is the ownership of any of the underlying assets passed on to the fund manager.

Like a doctor or a lawyer or a CA, fund managers provide a professional service. When you visit your doctor, do you ask him: how rich he is? No. You want to know how good he is.
When you hire a CA to write your accounts, do you ask them what their net worth is? No, you want a knowledgeable CA with a good track record to do your work for you.

Table 2:How good are you at your work, Doctor?

Name of largest equity fund of that fund houseBSE 200 IndexQuantum Long Term Equity FundReliance Growth FundBirla Sun Life Frontline Equity Fund-Plan AFidelity Equity FundHDFC Equity FundFranklin India Bluechip Fund
Size of largest diversified equity fund (Rs cr, as of April 2010) N.A 52 7,346 2,103 2,871 6,025.42 2,954.86
Returns from March 31, 2006 till May 20, 2010 for growth option 10.08% 16.31% 16.64% 17.07% 14.19% 16.35% 13.17%
3-year Ranking based on Value Research as of May 20, 2010*   18/175 17/175 32/175 57/175 13/175 47/175
Source: Value Research

But now, to get a fund manager, the sub-group recommends that they have a net worth of Rs 50 crore. That is the entry ticket to enter the sweepstakes of an industry that has, in the past fifteen years, shovelled thousand of crore of money from your pocket into the distributors’ pockets.

Capital solves all crimes.
Why would such intelligent people - and believe me they are - come out with such a morally bankrupt recommendation of hiking the net worth criteria after recognising that it is a "pass through" business?

Is this an attempt to keep a closed club closed?
To increase the barriers of entry so that a select group of mutual fund houses can reap the rewards of growth in the mutual fund industry?

We have often argued that net worth is not a legitimate criterion for setting up an AMC. As custodians of your hard earned savings, the mutual fund industry has to comply with various norms to ensure there is no fraud.

But, as we all know, intent is in the heart and in the DNA of organisations.

You can be big - and still be the biggest crook in the world.
You can be small - and still be a big crook.
Size and net worth is not a determinant of crookedness or working in the best interest of investors.

I know for a fact that Quantum Mutual Fund is small, yet we work in your interest. All the AMCs represented on the sub-group have been built on the opaque distribution model. That is their choice and their business plan, our DNA would never allow us to compromise your interest and leave you hanging by the relationship of a distribution commission.

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And neither is size or net worth a determinant of how good a fund house is at risk assessment and risk control.
UTI was big and they went bust.
CanBank Mutual Fund was big and they, too, had to be bailed out.

The largest mutual funds were the one’s who did not assess the risks of the Fixed Maturity Plans (FMPs). When faced with the severity of the Lehman crisis, they had to be bailed out by the actions of the RBI and/or their parent companies.

Their fear and obsession with that is apparent and referred to in the report. The dates they had their 3 meetings coincide with the dates of the depth of the crisis, suggesting that fear - and not rational thought - may have dominated their minds.

Table 3: Fixed Maturity Plans became unfixed.

Name of the AMC, mutual fund house BSE 200 Index Quantum Reliance Birla Sun Life Fidelity HDFC Franklin Templeton
Amount of money in FMP type products in September 2008 (Rs. cr) N.A zero 21,790 7,935 402 12,308.84 4,468.64
Source: Value Research

In fact, showing their state of shock at their own lack of risk assessment, the committee writes: "The liquidity squeeze in the last quarter of 2008 resulting in redemptions from a number of debt schemes, the difficulties that they faced, and the subsequent change of ownership of some AMCs have brought these issues into immediate focus."

Hogwash! The mutual funds and their marketing teams mis-sold FMP debt products linked to real estate developers as safe products (probably backed by good ratings from the rating agencies). Their larger AuMs probably got them high salaries and bonuses in 2007. Then their fiction of the safety of real estate loans caught up with them and they - and their investors - were in trouble. No, they went pleading for help to the RBI. And they got it. Yes, they got to keep their fat bonuses and rewards, too. Just like Wall Street did.

Now they sit in judgement as members of the sub group and feel that all AMCs need more net worth to protect themselves from their own greed? For a "pass through" business?

We are in the business of managing your savings to give you sensible, risk-adjusted returns over the long run. The elephants and the distributors have made it into an asset gathering business.

Should wrongdoings disqualify a mutual fund?
The solution to ensure that sensible people manage your money is not to have a high net worth (not that Rs 50 crore can save such risk-taking of an FMP business) for staying in the business.

The focus of the subgroup was on "eligibility norms" for being in the AMC business. This got translated into (i) minimum net worth; (ii) infrastructure and manpower required to run the business; (iii) other function that can strengthen and smoothen the functioning of these intermediaries.

One of the crucial aspects is missed out: the moral and regulatory right to remain in the mutual fund business after you are caught doing not-so-nice things.

Should companies that have paid thousands of crore of their investors’ money (without disclosing this) to various distributors have the right to remain in the business? Should mutual fund houses that have violated their own stated investment objectives be allowed to stay in the business? Should mutual funds that have mis-sold products have a license to continue functioning?

The recommendation of a higher net worth is a direct challenge on the regulator’s attempts to bring in more investor-focus in the mutual fund industry. Over the past year, SEBI has tried to build a more transparent mutual fund platform which widens the access to mutual funds at a lower cost. This sub-group is focused on limiting the choices available to investors and reversing SEBI’s focus on investor-friendliness.

Higher capital needs can only hide bad business models for a longer period of time. Just a little longer. Eventually a bad business model shows its weakness.

Rather than raising the capital needed to start a mutual fund business, the sub-group should have recommended dropping the net worth criteria to Rs 1 crore so that hundreds of new, smaller asset managers can set up. And they should be allowed to compete for the assets shovelled by distributors to the elephants. We need a lot of ants to get the mutual fund industry moving forward, the elephants have had their days of blocking the sun.

  • Also Read: The ant and the elephants

    Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)
    Quantum Long Term Equity Fund Quantum Gold Fund
    (NSE symbol: QGOLDHALF)
    Quantum Liquid Fund
    Why you
    should own
    An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
    Suggested allocation 80% 20% Keep aside money to meet your expenses for 6 months to 2 years
    Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

    Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.

  • Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)

    Quantum Long Term Equity Fund, Quantum Equity Fund of Funds, Quantum ESG India Fund Quantum Gold Savings Fund Quantum Liquid Fund
    Why you
    should own
    An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
    Suggested allocation 80% in total in both; Maybe 15% in QLTEF, 10% in Q ESG and 75% in QEFOF 20% Keep aside money to meet your expenses for 12 months to 3 years
    Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

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    11 Responses to "A Capital Crime: the myth of minimum net worth"


    Jun 6, 2010

    Mr.Ajith, you are absolutely right. There is no
    rationale for the proposed hike in the minimum net worth
    to Rs.50 Crores. Rs.10 Crores is more than enough to run
    an pass thru vehicle as MF.I have my money in your fund
    as well as in some of the larger funds. But alas, the
    performance of these so called stronger funds is average
    to pathetic compared to my investment in your fund. I
    sincerely hope better sense will prevail with the
    decision making authorities at SEBI and they scrap this

    Indira Acharya



    May 26, 2010

    This man keeps talking about ethics. How does he intend to explain the high expense ratios of his equity funds (2.5 & 2.1 in tax saver & LT equity respectively)? Aren't these high charges incurred by an investor due to the smaller capital size. Let us not forget that the high remuneration paid to the fund managers are out of the investors wallet. Besides, now that entry loads have been waived off across any fund house. 'Personalfn', a company started by this man has left investors lurching after having to change its policies to go online. Until this time the company was enjoying the benefits from distribution of mutual funds(across different companies) and immediately after the 'No load rule' the company in their website claimed that they had always been a fee based service provider. While this was clearly not the case. The man may defend saying he has got nothing to do with the day-to-day operations of the company but I'm sure as a board of director and as a ethical entrepreneur he could step up and take corrective measures. - Hypocritical at its best!!!



    May 24, 2010

    dear employees i am happy iam satisfication good people the above companys working all sites my fourite sites in my worth my satisfication next our comments iwas asspecteded thanking you be cajuse iwas a owner thanking you.



    May 24, 2010

    First of all, glad to see you are writing again. Missed you!!!
    A few questions on what you have raised:
    a. Is this a rule or something to be put up for public comments (as done for entry load, direct inv. etc. in past)?
    b. If not done without public comments, I see an ulterior motive - can SAT/RTI/CVC/SC be roused to put an end to this?
    c. How likely is it that Quantum will have to shut shop due to this - sorry for the candor?
    d. If you allow AMC to be owned by unit holders of QMF, will that be a way to raise the networth to required level?
    e. If you can bribe these SEBI guys to reverse the verdict, how much would it take? Can we contribute to this sluch fund as unitholders?
    In short, full support to you...
    Regards, Param



    May 23, 2010

    Ajit's points are very valid. The SEBI formed committee has 3 representations from so called very large AMC's, which might have influenced thoughts. But should SEBI not publish this and seek public opinion (like it was did in DTC) and take a call. The days of Too Big To Fail are gone and Small is Beautiful is here to stay forever.



    May 23, 2010

    Vijay, there is a big difference between the service rendered by a bank and that by a MF. Depositors need a bank primarily for safety of their capital, not for higher returns...so a bank is not allowed to pass-through its NPA losses to its depositors. Whereas a MF's service is providing return on investment, which necessitates a degree of risk - hence the caveat "MF investments are subject to market risk." Therefore, the capital requirements of the 2 businesses can't be equated.

    However, I do take your point that a reasonable net worth criterion is still required to keep out non-serious or fly-by-night players. So here, I do respectfully disagree with Mr. Dalal's suggestion of going the other way and lowering the minimum to below Rs. 10 crore.



    May 23, 2010

    I fully concur with your views.

    The people in the committee have vested interest.

    It is like telling people not to catch a thief in their home, if they see one, but to wait for the policeman to come.



    May 22, 2010

    Trust Quantum and put your savings in it. You will not lose out. What is being said is what is being followed at Quantum!! I am investing in it and no regrets so far!

    They maintain very high standards and professional ethics.



    May 22, 2010

    I think Vijay misunderstood Ajit's point. It is not about net worth but what matters as Ajit rightly pointed out intent and what is in DNA. Ajit and Quantum Mutual Fund please keep up good work.
    I am so happy to be invested in Quantum Long Term fund since its inception. Thanks once again.



    May 22, 2010

    how true.my close fund is a distributor and i asked him why he does not distribute quantum and the answer was the same. it is too small and risky.but i wanted to argue all funds are risky if the market collapses.
    the further thought is that the committee may or may not implement the recommendations.but what they have achieved is sown seeds of doubts and watered them well.
    so even persons who have invested in small funds become worried.what happens if the the recommendation is followed through.will we at least get back the money.because it s like banks .if everybody wants their money back at the same time(or even if one large investor wants his back)the fund is is hard put to service the requests in time.and that is when the rumor mills take over.it is certain that some funds are well managed and quantum is one of them.

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