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Infrarecommendations

Sebi recommendations on dedicated infrastructure funds have things that are inevitable, some that are innovative and some that make me uncomfortable

In his Budget 2007 speech, the Finance Minister spoke about the need to make as much investments as possible into infrastructure and said that the government would permit Dedicated Infrastructure Funds to encourage this. A committee was appointed by SEBI to report on how such funds should be structured. The needs of infrastructure projects really are very different. The gestation periods are long and for a variety of reasons, they are typically run by dedicated entities instead of existing listed corporates. This means that the liquidity and continuous valuations provided by the stock markets don't exist. This rules out the possibility of normal mutual funds investing in such projects. Now, the report of the committee is out and it has a range of suggestions that will make these funds very different from existing mutual funds.

Looking at the recommendations I can see some things that are inevitable, some that are innovative and some that make me uncomfortable. The biggest inevitability is that these funds will be closed-end. While I'm generally opposed to closed-end funds, the lack of liquidity in infrastructure means that being open-ended is not an option. They will be listed on the markets but as is normal with closed-end funds, the market price is likely to be less than the NAV. The report also calls for heavy tax incentives to encourage investment. It says that the Section 80C limit be doubled to Rs 2 lakh with the increase going to these funds and capital gains tax not be levied either.

However, the recommendations that stick in my throat are the ones concerning how fund companies will charge for running these funds. The report says that these funds will need dedicated research, management and monitoring teams that are distinct from existing teams so the management fee should be 44 per cent higher than the maximum chargeable by existing mutual funds. Actually, the report says that fees should be higher by 1 per cent of assets managed but that's a somewhat disingenuous arithmetic trick that just makes this massive hike look nominal. Let's make a clear comparison-for managing Rs 10,000 crore, existing funds can charge a maximum of Rs 225 crore (2.25 per cent of assets) and the new infrastructure funds will charge Rs 325 crore (3.25 per cent of assets). That's 44 per cent more, make no mistake.

Even worse is the recommendation that these funds be able to charge a performance fee which it claims is as per 'globally accepted best practices'. This is simply untrue. Globally, performance fees are charged by hedge funds, not mutual funds. Alarmingly, the report completely ignores this fact. Hedge funds are barely-regulated entities that are open not to retail investors (as these funds will be) but only to people who are investing large sums of money. None other than Warren Buffett calls these performance fees 'a grotesque arrangement'. Basically, performance fees mean that the fund manager is a partner in investor's profits but not losses. To create a class of funds which will be very attractive to retail investors because of tax breaks carved out of government revenue, but which are designed to hand over a generous part of the investors' returns (over and above a generous management fee) to fund companies looks to me like a grotesque arrangement.

Anyhow, these are just recommendations and we'll get back to this when the actual regulations come out.