Money management: profession or business?
Barriers and restrictive regulations have made selling mutual funds more a business than just a professional activity
By Parag Parikh | Nov 30, 2013
The author is the CEO of PPFAS Mutual Fund.
If money management is a profession then the professional does what is good for the client, in the belief that doing so is advisable, both for his/her long-term success, as well as for the well being of the profession. However, if it is a business then each action of the provider will be scrutinised as to whether it makes business sense or not. Often in a business, business interests supercede the interest of clients.
I strongly believe that money management in all its forms should be a profession, but in India the presence of high entry barriers and restrictive regulations have turned it in to a business. The net result is an inordinate stress on marketing the product, being beholden to distributors, needlessly launching multiple, often overlapping schemes, and the perennial race to be on top of the 'Assets Under Management' league table.
In this aspect, we are at variance with the world, where, by and large, money management is considered a profession in which capital requirements do not act as material entry barriers. Hence, competent professionals are not barred merely because they do not have the wherewithal to bankroll their new venture. For instance, in the USA one requires just $100,000 to set up an Asset Management Company (AMC). In the UK and the European Union it is the equivalent of Euro 1,25,000 and in Singapore it is 2,50,000 SGD. Surprisingly Japan does not stipulate any such minimum criterion. Hence, other things being equal, one requires just the cumulative equivalent of Rs 3 crore to register as a global asset manager. Conversely, in India we not only suffer from a high entry barrier of Rs 10 crore, there are proposals that it be raised even higher.
Those advocating higher net worth have two arguments to support their claim:
1. High net worth will be instrumental in ensuring that only serious and committed players throw their hat into the ring.
2. As those with deep pockets can open more branches, this will aid the objective of countrywide penetration.
It has been rightly argued several times that since a mutual fund is a pass-through vehicle which does not rely on its balance sheet for growth, prima facie any stipulation pertaining to capital requirement is superfluous. What is required is intellectual capital. This could manifest itself as -- Passion for investing, knowledge and experience of markets, an investment style which is in congruent with one's publicly stated core beliefs and the unwavering commitment to act as a fiduciary.
The belief that deep pockets reflect commitment is not necessarily true. Over the years, we have witnessed several renowned and highly capitalised promoters throw in the towel within a few years of launching their AMCs. Fidelity, Bharti-AXA and ABN Amro are a few cases in point. Surely this belies the contention that high net worth is a proxy for seriousness.
Excessive capital contribution may also lead to cost escalations in terms of salaries and commissions, which in turn will adversely impact the industry's cost structure, much to the detriment of investors. Actually, even today there is no stipulation regarding 'maximum permissible capital' and hence players who want to a pursue business strategy involving large capital commitment are permitted to do so.
If the proposed norms come into effect, it may paradoxically become less attractive for a new player to set up an AMC as the higher capital deployed will increase the break-even period and also adversely affect the Return on Equity (RoE). In other words, a viable profession may actually turn unviable. Also, if the retrospective implementation of these norms leads to existing players folding up, it may foster an unhealthy oligopoly dominated by today's large players.
It appears that the proposal rests on an erroneous interpretation of the principle of 'Skin In The Game'. True it is not synonymous with a higher capitalised AMC, but is evident when sponsors, managers, directors, etc., invest in the mutual fund's scheme. This willingness to sink or swim with the investors represents true alignment.
Also, 'Skin In The Game' could be relative, and not an absolute number. For instance, Rs 100 crore may not be a material figure for a large conglomerate while Rs 10 crore may be significant for professionals.
Besides, some of the well capitalised fund houses and their associates have been at the receiving end of punitive actions taken by Sebi. Hence, unfortunately, there is not enough empirical evidence to suggest that a larger balance sheet results in a more trustworthy fiduciary.
Here is another unintended fallout of the new proposals: It could send wrong signals to investors who may assume that the sponsor's net worth may actually serve as an implicit safety net, protecting them from any future losses suffered by them.
Also, achieving penetration by opening new branches is an idea whose time has gone. It is a high cost model and it is dead. We are in the internet era where many transactions are conducted online.
In the era of digital revolution physical presence is less significant. There are third party execution platforms like registrars and stock exchanges which ensure that the fund house can reach out to investors in remote corners. Also, excessive emphasis on selling, coupled with skewed incentives in remote areas may actually lead to predatory practices, including misselling. Besides, given that urbanisation is gathering momentum, setting up physical infrastructure to cater to rural areas may not yield the desired effect.
Considering the delayed feedback inherent in mutual funds, selling them calls for professionals with passion and expertise to educate clients about the pros and cons of investing. A mature market like USA has more than 600 asset management companies whereas in India we have just over 50. Even currently, we have enough checks and balances in place to ensure that investors are protected from professional misdemeanours. Besides, safeguarding one's reputation is of paramount importance for professionals, as often, this intangible asset is the only one they possess. I intuitively feel that they are likely to exercise much greater care as compared to a conglomerate for whom this is only one of many activities.
I have a rather radical suggestion: Why not reduce the capital requirement or do away with it alltogether? After all, if entry barriers have to be imposed, let them be intellectual than monetary.
This column first appeared in the December 2013 issue of Mutual Fund Insight.