Are MF trustees trustworthy?
The functions of trusteeship are best left to professional firms
M DAMODARAN
A
s the entry level vehicle for first-time
investors in the securities market,
mutual funds (MFs) have, over the
years, discharged their functions re-
sponsibly. Therefore, any blowout in one or
more schemes of any MF, gives rise to apprehen-
sion and anxiety. The protestations of the MF in-
dustry that one isolated incident should not
lead to decreasing confidence in the industry, is
not bought into by several investors, who for
long have believed that nothing can go wrong
with MFs.
At a roundtable organised by Excellence Ena-
blers (www.excellenceenablers.com), a corporate
governance advisory firm, several issues, con-
cerns, suggestions and solutions surfaced.
There are two warnings which the MF in-
dustry has been putting out over the years. The
first is “Mutual funds are subject to market risks.
Please read the offer document carefully before
investing”. The second is the proposition that
“Past performance is not a guarantee of future
returns”. If the problems disappeared with
these two cautions, the industry would have
been a better place.
However, in pursuit of the goal of delivering
better returns than competition, many fund
managers have, over the years, resorted to ag-
gressive investment practices that, luckily for
them, have not gone horribly wrong. In the re-
cent high-profile meltdown in a few schemes of
the Fund house, the root cause has been identi-
fied as the aggressive investment style of the
fund manager, straying into areas where angels
(read other fund managers) fear to tread.
So long as the returns are right, no one ever
complains. The fundamental principle that “the
higher the risk, the higher the reward”, or, to
turn it on its head, “the higher the reward, the
higher the risk”, is either not understood or is
ignored.
Over the years, SEBI has mandated several
risk-management practices, including, but not
limited to, the management of liquidity risk. It
must however be recognised that a Regulator
cannot, and should not, micromanage invest-
ment decisions, and should merely ensure that
they are consistent with the stated investment
philosophy.
Oversight, on a continuing basis, is some-
thing that cannot be ignored, and this is where
Trustees come into the picture. The Trustees are
the custodians of the Funds, and it necessarily
becomes a significant part of their responsibil-
ity to ensure that fund management is carried
out in a manner that does not put at risk the
funds invested in various schemes. For a num-
Markets can ill-afford a distrust of mutual funds
ber of reasons, Trustees, by and large, have been
found to have not measured up to expectations.
Selection of trustee
The first element, in this complex structure-de-
rived problem, is that the AMC has a significant
role in selecting the Trustees. At a basic level, this
corresponds to students in an examination hall
selecting their invigilators. The theory, of
course, is that Trustees select the AMC, which
manages the fund, and are empowered to the
extent of being able to change the AMC, and to
bring in a new fund management team. How-
ever, when Trustees are appointed by the Spon-
sors, whose influence is significant on the AMC
Board, it would be futile to expect that Trustees
can, without reservation, call the shots.
The Trustee Board, which has the function of
oversight, consists of independent Trustees and
non-independent Trustees. The latter category
normally includes representatives of Sponsors,
as well as a representative of executive manage-
ment. Given the role and responsibilities of the
Trustees, there is a legitimate expectation that
they will provide first level regulation in the MF
industry.
Either because of a lack of role clarity or be-
cause of not being adequately empowered situ-
ationally, Trustees have not been able to ensure
that fund management is carried on strictly in
accordance with the investment philosophy of
the Fund house.
A part of the problem is that in the selection
of Trustees, there is no way of ensuring that only
persons who have a first-hand experience of the
industry are persuaded to join the Board of the
Trustee company. The MF industry being differ-
ent from the other elements of the financial sec-
tor, it would be unfair to expect everyone with
financial sector expertise, to hit the ground run-
ning on the Trustee Board of an MF.
The related issue is that these are part-time
functionaries, who interact with the AMC Board
and the fund managers mostly on the dates
when the Board meets. The information asym-
metry which they suffer from adversely impacts
on their ability to provide the right kind, and the
right extent, of oversight.
There is a related problem that investors in
the MF industry experience. Their expectation is
that the existence of a Trustee Board in an MF is a
guarantee against any misadventure by the
fund management team. It is when fundhold-
ers recognise the expectation reality-mismatch,
that confidence in the industry tends to suffer.
Like most other activities, trusteeship in the
area of fund management is a specialisation
which by itself is a product of experience and ex-
pertise, and the consequent willingness to take
up the role of a Trustee. In a few countries this
realisation has led to the creation of profes-
sional trustee companies which, for a fee, enter
into an agreement with the Sponsors, to carry
out the functions of trusteeship, including fund
valuation, fund auditing and fund accounting.
With more and more investors taking the MF
route into the securities market, it is necessary
to seriously consider whether the function of
trusteeship should be assigned contractually to
professional Trustees.
Misconception about AMFI
There is another misconception which needs to
be addressed. A number of otherwise well-in-
formed persons believe that AMFI is a self-regu-
latory organisation (SRO) for the MF industry.
AMFI was born as an industry body, to represent
the interests of the AMCs. To expect an industry
body to dispassionately and objectively dis-
charge a regulatory function is a fairly big ask.
While AMFI might promote best practices, as
many industry organisations do, it does not
translate to self-regulation, without the ele-
ment of enforcement tagged thereto. One pos-
sible way of taking advantage of the represent-
ative nature of AMFI is to split AMFI into two
organisations, with industry concerns and de-
velopment being addressed by one of the two
entities, and regulatory aspects by the other en-
tity. The FINRA model, a carve out of NYSE (with
NASD associated with the new entity) would be
worth pursuing.
Mutual Fund Sahi Hai is a persuasive and com-
forting comment. However, the rare instance,
when reality seeks to disconnect with percep-
tion, could drive the fence-sitters away from the
funds, and even from markets. That is a luxury
which no market can afford.
The writer is Chairperson, Excellence Enablers and
former Chairman, SEBI, UTI and IDBI