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MFs Get NFO-Happy on Deadline

Funds are targeting investors as the ban on commissions approaches

After being floored by the law change that banned the charging of entry loads from investors by distributors by the Securities and Exchange Board of India (SEBI), the mutual fund (MF) industry has suddenly become a hub of hectic activity.

The reason behind the hustle and bustle is the industry’s desire to beat the SEBI-set deadline of August 1, when the rule comes into effect that will prevent investors being charged for investing in MF products -- irrespective of the mode of investment, direct (with fund house) or indirect (through distributor).

Needless to say, with their commissions, 2.25 per cent of the invested amount, being halted, distributors have said they will boycott MF products from next month.

Seeing that they may no longer be able to generate large amounts of new money for themselves in the near future, without the aid of distributors, fund houses are looking at launching new fund offers (NFOs) as soon as possible to beat the deadline and thereby harness the energy and distribution reach of the distributors or fund advisors.

However, what has encouraged AMCs to jump on the NFO-happy bandwagon has not just been the ban on entry loads, or the imminent departure of distributors. A bit of recent history is egging them on too – with the markets rising March onwards, the timing may also be right.

But amongst the most important reasons is the performance of the recently-concluded Reliance Infrastructure NFO, which was lucky enough to debut when the markets were high and investors flocked to it, helping the fund house to mobilise as much as Rs 2,350 crore. The NFO opened on May 25, just a week after Sensex gained as much as 17.34 per cent after it became clear that the Congress government had won enough seats to be able to dictate terms to its coalition partners, rather than vice versa that was the case in its previous term. Sensex had virtually climbed vertically in May from 12,134.75 points on May 4 to 14,625. 25 points on May 29. Before that, ICICI Prudential Target Returns Fund had managed to garner as much as Rs 800 crore after it was launched on April 15 – Sensex jumped from 9,901.99 points on April 1 to 11,403.25 points on April 29.

Unwilling to take a chance on distributors not being fully co-operative this time around, fund houses have resorted to adding on incentives, to make for a more lucrative deal for them. This will virtually guarantee that distributors participate aggressively in selling MF NFOs, at least till the end of this month -- an enlightened final fare-thee-well gesture, so to speak.

Otherwise, fund houses will find it very difficult to spread out across the country's various districts on their own. The other investment option open to investors, direct investment in a fund house, has limited reach, mostly in major towns and cities.

The hike in commissions is astonishing as some AMCs are looking to pay as much as 3-4 per cent brokerage.

While 2.25 per cent entry load charged from investors will take care of most of the outgo on commissions, fund houses are looking to guard their rear from any emergencies by clamping down a high exit load – this will discourage investors from redeeming.

With the situation so uncertain across a whole array of parameters, funds will look to hike the exit loads as high as possible – entry+exit loads can add up to 7 per cent maximum as per SEBI rules. That means the fund house can impose a levy as high as 4.75 per cent – a truly behemoth amount that will keep all thoughts about redemptions away from the minds of investors.

The idea by the funds is to generate profit for themselves by retaining investors money for as long as possible, only then will they be able to make hiked commissions to distributors viable.

While that may serve as a deterrent, yet another factor may come into play that may encourage investors to pull out of their investments.

The goal of investors is to make profit. They will give the money to funds in order to make decent gains at low-to-medium risk. And the profit angle is dependent on the performance of stock markets. If they underperform, or, as happened in 2008, they dive down vertically, it will cause widespread panic among investors who may choose to redeem their money rather than book further losses.

While stock markets have been on a high since March, they have been flat for the month of June. Their future trend can be hypothetically surmised to an extent by what happened after the presentation of the Budget.

Since Finance Minister Pranab Mukherjee did not unveil any pro-market or pro-reform agenda, the bourses have fallen. The fact that the fiscal deficit is pegged at 6.8 per cent, in an attempt to rejuvenate the economy, has also not gone down well with markets. It looks unsustainable and that is the reason that is attributed to the sudden exodus by foreign institutional investors (FIIs) since June 6, causing the markets to plunge further.

After having paid so much in commissions and not having had the opportunity to generate gains as the money was redeemed, mutual funds may find the whole exercise was not very gainful for them. Except for the distributors, the other two entities would have had a bad experience.

The situation is laden with doubt and dangers abound at every corner. But for funds that have opted to go boldly into the markets with their NFOs, with the bit firmly clasped in their teeth, this may well turn out to be a chimera that they are chasing. And the worst part is, the fantasy may well turn out to be a tragedy in the form of a bear hug.

Among the NFOs running currently are DSP Blackrock World Energy FoF, Quantum Equity FoF, and Franklin Build India Fund. Those still in the works are Mirae Asset China Advantage, Tata Small and Midcap Infrastructure Fund and Shinsei Industry. SEBI is yet to clear their offer documents.