Fund companies are now becoming increasingly vocal about the maelstrom unleashed by SEBI’s regulatory moves. But do they need to look at their own actions and flawed business models too?

After putting up a brave face for most part of the year about the market regulator's frequent changes, fund companies are slowly but surely exhibiting frustration. While the steady erosion in the corpus of mutual funds has caused some discomfort among asset management companies (AMCs), the recent sharp decline in profits seem to be the tipping point for fund companies. The Mint, which has been an unstinted champion of regulatory actions, naively arguing that they were pro-investor, has now started to voice concerns of the fund companies about the regulator's actions.

Till only a few months ago, AMCs were strangely silent about the whirlwind regulatory changes introduced by the Securities and Exchange Board of India (SEBI). Despite the turmoil that they experienced, AMCs agreed that they would be able to "adjust" to the changes. Now, fund companies are becoming vocal in their criticism of the regulator's actions. SEBI, meanwhile, thinks that companies are coping well with the regulations.

Faced with a sharp reduction in profits amid continuing haemorrhaging of assets under management (AUM), AMCs are not willing to suffer silently any more. Equity mutual funds have witnessed an outflow of Rs29,000 crore so far in this calendar year. Since the ban on entry load imposed by SEBI last August, the total outflow has touched a whopping Rs38,500 crore.

However, this drain was not reflected in the financial results of fund companies for the year ended March 2010. This was because of the phenomenal surge in stock markets that got transferred on to the balance sheet and income statements of the companies. The resulting inflation in the value of AUMs was responsible for the companies showing healthy profits in their books for the last year, since fund companies make a percentage of AUMs. Now however, the story is quite different. The Mint report points out that several AMCs have reported a sharp decline in profits, with some like ICICI Prudential Asset Management Co and Kotak Mahindra Asset Management Co even posting losses for the quarter ended September 2010.

Naturally, AMCs are a worried lot. But while they are fair in their criticism of SEBI's mostly ill-conceived and ill-timed initiatives over the last year, the fact remains that AMCs had it coming for a long time. Among the chief reasons that prompted SEBI to put an end to the entry-load mechanism in mutual funds was the past excesses of fund companies. The boom period between 2005 and 2007 saw AMCs churn out new fund offers (NFOs) at a frenetic pace in a bid to capture volumes and generate more and more AUMs. This came at the expense of product and service quality.

Fund companies were actively encouraging distributors to advise investors to sell their existing funds and subscribe to NFOs. They shamelessly enticed investors with the logic that NFOs were priced at Rs10-supposedly much cheaper than existing units-when actually the issue price of NFOs is meaningless. In order to incentivise distributors to sell these NFOs, funds plied them with lavish gifts and even took them on foreign trips.

Another self-inflicting factor for AMCs has been their flawed business model. The way it is structured is that fund companies are practically at the mercy of distributors to sell their products for them. With little retail contact base of their own, these AMCs are dependent on selling skills of distributors to generate revenues. With SEBI now having dealt a telling blow to the distributor community by taking out their commissions, AMCs are suddenly left without any muscle.
Obviously, fund companies now have to substantially alter their business models to suit the altered landscape of the industry. Otherwise, a wave of consolidation of sorts could very well be on the cards.