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Funds in a Glass House?

As the mutual fund industry manages greater and greater amounts of money invested in stocks, we need more, perhaps much more transparency about funds' actions in the markets

Currently, three fund managers of Indian mutual funds are under investigation for being part of a stock price manipulation racket. The details of the cases are complicated, but it boils down to this: these men are being investigated for using investors' funds at their disposal to help influence stock prices. Allegedly, their manipulations helped some market operators make money, while causing losses for the funds they were managing.

Of the three, Sandip Sabharwal was till recently one of the star fund managers of India. From 2000 to 2004, Sabharwal's brilliant investment management of SBI Mutual Fund's once-moribund funds made investors huge amounts of money and was arguably a major factor in bringing the State Bank of India's mutual funds business back from the dead. Subsequently, Sabharwal joined Lotus, a new mutual fund company that is about to be launched. Now, it appears that he has left that job as a result of the investigations.

Now I have no idea whether these people are guilty or innocent of the crimes for which they are being investigated. However, I'm certain of one thing. As the mutual fund industry manages greater and greater amounts of money invested in stocks, we need more, perhaps much more transparency about funds' actions in the markets. While everyone is celebrating the rise of Indian mutual funds one must pay attention to the fact that with their vastly increased assets comes a vastly increased ability to influence the markets and impact stock prices.

Five years ago, the more powerful fund managers in India had perhaps a couple of hundred crores at their disposal. If any of them wanted to manipulate a stock, they would, practically speaking, have been unable to make available more than five or ten crores to fool around in a particular scrip. That sort of money wasn't chickenfeed but it certainly wouldn't count as the kind of deep pockets you needed to fight price-fixing battles with entrenched market operators.

Nowadays, things are different. The mega-IPOs and the strong markets of the last two years have meant that the fund industry has at its disposal a humongous Rs 300,000 crores. There are individual fund managers who are managing thousands of crores of investible surplus. For the fund industry to have a healthy future, it is not just necessary that all investment management be done in a clean and ethical manner, it is also necessary that it should publically be seen to be done in a provably clean manner.

There are two ways of achieving this-greater policing or greater transparency. Clearly, greater transparency is the better path. I think SEBI should proactively take cognizance of the lurking dangers and evolve a much more rigorous regime of mandatory disclosure of investment portfolios than is being followed right now. Currently, funds are required to reveal their portfolios once every six months. Most of them voluntarily release some information every month but increasingly, others stick to the bare minimum that the law mandates. This is a disturbing trend and given the sad history of scandals in India's financial services industry, I'm sure this will one day contribute to a scam that will shake investors' faith in mutual funds as well as in the regulator.

The normal argument given against frequent disclosures is that it allows rival funds to get to know of a fund managers' investment ideas. This problem is easily addressed by having frequent, but time-delayed revelations. For example, funds could be asked to reveal portfolios daily, but with a delay of three or even six months. In any case, the current law of six-monthly revelations is just not adequately stringent given the newly-acquired trading muscle that mutual funds have. The time has come for a financial services equivalent of the Right to Information Act.

Like Caesar's wife, those who manage other people's money must ensure that not only are they above suspicion, but just about any member of the public must be able to check for himself that they deserve to be above suspicion.