Mumbai: Capital markets regulator Securities and Exchange Board of India (SEBI) on Friday cautioned against the “increasing incestuous relationship” that mutual fund (MF) players are developing with their rating agencies and called for maintaining an “arms-length relationship” with these agencies in larger interest.

“What worries me is the increasing incestuous relationship between the mutual fund players and their rating agencies. The MF industry has to evolve a policy to maintain am arms-length relationship with fund rating agencies,” SEBI executive director KN Vaidyanathan told reporters here.

“The fund rating as we see today are more relationship-based and not driven by the fundamentals of the product,” Mr Vaidyanathan, who looks after mutual funds at SEBI, said while addressing the India Investment Conference organised by the Chartered Financial Analyst (CFA) Institute and the Indian Institute of Securities Markets here.

“The least the industry can do is not to get their funds and rated corporate papers rated by the same agency,” he said and added that it is time that the industry came together and raised the bar for themselves.

He also urged fund managers to worry more about the NAV (net asset value) of their equity traded products and not their margins alone. “The excessive dependence on the window-dressing by the fund managers should end,” he said.

Pointing out that fund managers are increasingly doing more of self-serving functions, he said without properly protecting NAV, a fund manager cannot carry out his fiduciary functions properly and effectively.

Later speaking on the sidelines, he said SEBI prefers the entire industry follow “a brain-dead benchmark” like the Nifty or Sensex which some fund houses are already using. “I think seven or eight funds are already using the Nifty or the Sensex as a consistent benchmark, and we think this is a good thing. We hope the competitive pressure will drive everybody to adopt the idea.”

On whether there will be more regulations on the MF front, he said in time, the entire MF industry will be regulated by SEBI.

On the product regulation front, he said first the watchdog is trying to see if it can get some standardisation on the product before going into the selling side. “We are working on product labelling simplification and then (will) try to bring down the variables where there can be mis-selling. I think we are halfway there.”

He went on to add that, “what is a matter of concern to us is whether investors’ interest is being very badly compromised because of the skewed nature of incentive to the seller, the manufacturer or the relationship manager. It’s not specific to an individual product. If you were to get into mis-selling, you need to understand the incentive structure.”

When pointed out that the industry has of late been bleeding as it entered the new regulatory environment, he said, “I am satisfied that the changes have been accepted.

The industry has done an outstanding job in adapting to the new regulatory environment.”

He also said SEBI is satisfied that MF houses are consciously investing time, energy and resources in training sales force, in bringing distributors and are putting in place a technology framework that can help scale the business through the stock exchange platform. The results will happen with time.

“I think over the next one or two years, as savings increase, I believe that the MF industry will be very well- positioned in getting a larger allocation of savings,” he said.

He further explained that one should look at three numbers when it comes to MF performance—the NFO (new fund offer) inflows, existing scheme inflows and outflows.

Outflow is a function of multiple factors. That is not driven exclusively by the AMC or even the distributor. NFO is something SEBI does not want unless there is a good reason. In so far as inflows into existing schemes are concerned it has gone up from Rs4,000 crore to Rs5,500 crore per month, he explained.

“The decreasing number of portfolios is a wrong way of looking at it. The right way to look at it is the number of unique customers and our data says that there has been no change in that,” he concluded.