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Are my investments safe?

The Karvy scandal raises the obvious in the minds of many investors. Mutual funds have the right answer

Are my investments safe?

Are my investments safe? It's the first question that any investor asks. If you ask this question from an expert, then logically it must be answered by a counter-question, "Safe from what?"

When you make any investment, there are different kinds of threats to its safety. Broadly, they might fit into two categories. One, its inherent investment value may decline. Or two, someone else, who is not authorised to do so, may liquidate it and run away with the money. Savers who invest in equities or equity-backed mutual funds are generally prepared, to some degree, for the first type of threat. That's part and parcel of the returns-vs-risks spectrum that one signs up for when making an equity-backed investment.

The second type of threat is different. It's an out-and-out crime, no different from someone robbing you and running away with your money. One would expect that such threats would materialise either not at all, or at a very marginal scale, but as the recent experience of Karvy Stock Broking shows, that expectation is not realistic. From what SEBI's investigation shows, it appears that the stockbroking firm (or some persons within it) pulled off a fairly elaborate heist. At one level, one could call such a fraud unprecedented, in the sense that precisely this kind of fraud has never been done before at this scale. Smaller stockbrokers have certainly done something fairly similar I believe.

However, in a broader sense, we all have a sense that frauds using digital transactions are increasing. For example, everyone definitely gets the impression that digital pilferage from bank accounts is happening at quite a large scale. We all seem to know of more than one such case within one's personal circle of acquaintances. Similarly, the PayTM KYC scam seems to be widespread enough for the company to be spending considerable effort to warn people not to fall for these frauds. Many people have a certain sense of being under siege from frauds that they do not understand and therefore cannot guard against. In the physical world, we all know how to buy and use a stronger lock. In the world of digital transactions, it's hard to be confident that you know how to prevent yourself from getting robbed. In fact, it's hard to be confident that you have not already been robbed and you just don't know about it yet!

From a savers' and investors' perspective, a natural question that arises is whether mutual fund investments may be vulnerable to the Karvy kind of scam. As the Karvy scandal shows, what your broker tells you about your stock holdings could well be fictional. Just like it happened there, does it also mean that for your mutual fund holdings, you should also worry that some intermediary is going to take possession of your funds, sell them off and appropriate the proceeds? According to the conclusion that a SEBI investigation has come to, that is what Karvy Stock Broking did with several hundred crore rupees' worth of shares that belonged to its clients. The shares were transferred from the clients' depository accounts, sold off and the proceeds transferred to Karvy's real estate business.

I'm not going to stick my neck out and say that no fraud of any kind is possible with mutual funds, but this kind of thing can pretty much be ruled out. In stock investing, the stockbroker is an actual intermediary. You deal with the broker and the broker carries out the transactions. With mutual funds, there may be a sales intermediary, but the financial transaction is between you and the mutual fund - not even the fund company, but the specific mutual fund scheme in which you have invested. Not just that, the bank account from which the money goes to the fund and the one to which it comes back must be the same. The fund holding must also be in the same name as the bank account. Essentially, with mutual funds, there is no intermediary in the transaction itself.

The structure is one which is much simpler than stocks, with no real variation permitted. Essentially, mutual funds are much more suited to the consumer kind of hands-off investor who does not have the wherewithal to mount the kind of 24-hour vigilance that other types of investment transactions require.