SEBI has delivered the latest instalment in the wave of reforms that have swept over mutual funds after the liquidity crisis last year. Earlier, the regulatory agency has fixed some of the obvious problems that contributed to the liquidity crisis. Issues like NAVs based on illiquid investments, closed-end funds which allowed premature redemption, and long maturities in liquid funds have been tackled earlier. Now, SEBI has gotten down to cleaning up funds’ portfolio revelations. This is a less obvious problem, but one which not only contributed to the liquidity crisis but also makes debt funds less understandable by investors and analysts. As someone who has been studying data released by funds for close to decades now, I can vouch for the fact that there is effectively far less transparency in debt funds than there is in equity funds.
On the face of this, this discrepancy shouldn’t be there. After all, the two are governed by the same regulations. However, the difference arises from the nature of equities vis-à-vis that of debt securities. In their portfolio declaration, funds generally list the name of a security and the quantum of their investment in it. There can be more information, but this is the core set that is always there. For equities, this is quite enough. However, in the case of debt, the very identity of a debt security is difficult to determine. For starters, the same company can—and normally does—issue many different debt securities. Unlike equity, there is no standard nomenclature that can identify and differentiate between these.
While these problems are somewhat manageable for normal corporate bonds, the taxonomy of more complex debt instruments is far tougher. Securitised debt instruments generally have many parties involved. The debt originates with one party, and is then repackaged by another, perhaps pooling it with other similar or dissimilar debt. In these cases, the name or description of the security as it appears in a fund’s portfolio declaration almost never carries enough information for unambiguous identification.
Worse, the lack of a standard nomenclature means that the same security could appear under different names in different funds’ portfolios. This has grave implications for investors. As things stand now, investors cannot reliably combine the portfolios of different debt funds and see what their combined exposure to a given security or borrower or sector is.
SEBI’s new rules mandate a richly detailed format for declaring debt portfolios that takes care of all these problems. This is a huge step forward for bringing transparency to individual funds’ portfolios. However, they are not a complete solution for investors. Debt investors need to easily aggregate their holdings across different funds to be able to analyse their risk exposure without doing heavy detective work. This need can only be met by each security having a specific identification symbol that is universally recognised. Such a system already exists and is called the International Securities Identification Number (ISIN). In India, ISINs are there for many but not all debt securities.
The logical final solution for the declaration of all investment portfolios, be they of mutual funds or insurance schemes or anyone else, is to make them purely ISIN-based. This will work for equities and also for international holdings because the ISIN system is global. Let’s hope that the new system leads to a universal ISIN-based system soon.
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