SEBI wants to create a new category of fund sellers: Postal agents, retired teachers, retired government and semi-government officials who will sell units of ‘simple’ and ‘performing’ mutual fund schemes. The concept and the definition of these two terms should rank pretty high in the list of harebrained ideas from regulators

The Securities and Exchange Board of India (SEBI) recently passed a circular that sharply increases charges for mutual fund investors. This by far is the worst we have seen from the market watchdog. Apart from penalising long-term investors (Read: Mutual funds to be expensive from 1st October ) SEBI’s circular also states “A new cadre of distributors, such as postal agents, retired government and semi-government officials (class III and above or equivalent) with a service of at least 10 years, retired teachers with a service of at least 10 years, retired bank officers with a service of at least 10 years, and other similar persons (such as bank correspondents) as may be notified by AMFI/AMC from time to time, shall be allowed to sell units of simple and performing mutual fund schemes.”
 

Now what is SEBI’s ‘simple’ and ‘performing’ mutual fund schemes? SEBI has helpfully defined it: “diversified equity schemes, fixed maturity plans (FMPs) and index schemes.” If SEBI considers diversified equity schemes as simple, we wonder why SEBI has not included debt income schemes and liquid schemes as well and which are not complex? And FMPs were the main cause of distress for investors and SEBI in the 2008 crash, which wiped out a fund house.
 

But what is even more intriguing is the second part of the idea. The schemes “should have returns equal to or better than their scheme benchmark returns during each of the last three years.” (our emphasis). This criterion for selecting schemes is not only wrong but investing in certain schemes based on this can be harmful to one’s investment. And what’s worse is that this would be the investments of hard earned money of savers from small towns and cities who would invest on the trusted advice of ‘government’ employees, postal agents, teachers and ‘senior’ bank officers.
 

Schemes that beat their benchmark in each of the last three years are not necessarily consistent performers. Take for example the scenario in August 2007, had one planned to invest at that time there would have been funds like SBI Magnum Global Fund 94, Reliance Vision and DSP BlackRock India Tiger Fund among the list of schemes that beat their benchmark on each of the last three years. What happened subsequently?

• • In the following year itself the schemes fell by 10% to 17% whereas their benchmarks had fallen by just 3% to 5%.
   
• • In fact none of these three schemes made it to the list in any of the subsequent years till now based on the same criteria.
   
• • Half of the schemes present in that year never met the criteria for the following year. This is one reason why we emphasise that while selecting a scheme one should focus on long-term consistence performance.
   

Let’s take the most recent period just for making our point clear.
 

• • At the end of August last year there were 51 equity diversified schemes that met the criteria of the SEBI circular.
   
• • The following year as many as 18 schemes failed to beat their benchmark and around eight schemes delivered negative returns compared to their benchmarks which were positive.
   

Here are some more issues that show how foolish SEBI’s idea of ‘performing’ schemes is.
 

• • Returns are always considered point-to-point. We have explained the fallacy of taking returns over a fixed period (read it here Three reasons why S&P-CRISIL’s rating of mutual funds based on fixed period is flawed ). Here even though the performance over each of the last three years is taken it is not enough.
   
• • Some good schemes may have failed to outperform their benchmark for just one particular period that too by a negligible amount. If we apply the above mandate it would mean the particular good scheme would fail to make it to the list of “simple and performing” schemes. Take for example HDFC Top 200, it marginally underperformed its benchmark in August 2007 by one percentage point (the scheme had returned 31% compared to the BSE 200 which returned 32%). This would mean it would not be present on the list of schemes for that year and the following two years even though it substantially outperformed its benchmark in the following two years.
   

And as long as SEBI allows fund companies to charge 1.5% on index funds, allowing retired teachers to sell index funds to the masses is patently doing severe harm.
 

Would the retired government officials be able to do their own research and select the top schemes or would they just push the schemes that would earn them higher incentives? Who would be responsible if investors lost their hard-earned money by investing in the wrong scheme? After all, SEBI has only found new ways to bribe mutual funds companies to reach them, not protect their interests with appropriate metrics and making fund houses and sellers accountable.
 

Bureaucrats who run the regulatory bodies come up ideas that are well-meaning but senseless because of their tendency to bring in value judgements that have little to do with reality. In 1992 when Dr Manmohan Singh declared that foreign funds would be allowed to invest in India, he said only ‘reputed’ institutions would be allowed to invest here. Dr Singh’s value judgement looked ridiculous and even more so with the reputation of Wall Street firms like Goldman Sachs, Merrill Lynch, Citi and Morgan Stanley in tatters after their role in sub-prime crisis of 2007-08 came to light.
 

We suspect that this breathtakingly silly idea will remain stillborn like many other ivory-tower ideas of regulators. This is simply because it is not possible to implement it and neither will there be any takers for it.