SEBI reforms to increase efficiency of MF industry: Kudva

The Securities and Exchange Board of India (SEBI) announced a slew of reforms to benefit the mutual fund industry along with the approval for eIPOs. Vivek Kudva of Franklin Templeton Investments hails this as a positive move and believes this will help the asset management companies, distribution companies as well as the investors.

Kudva is also hopeful of further reforms and is of the view that this will make the industry much more efficient. He also looks at the changes in exit load positively, adding that it is eventually going to benefit the end investors who remain invested in the funds. Here is the edited transcript of the interview on CNBC-TV18. Q: Is this addressing the structural issues, do you think we will see additional inflows, particularly from retail and will it make fund raising easier, have the structural issues been addressed?
A: I think changes announced by SEBI are all very positive and I definitely think it will help all the three constituents, the asset management companies, the distribution companies as well as the end investors. This I would say is the first phase in a series of reforms.
I think they are additional reforms and changes that are required. I am hopeful that along with the ministry, SEBI will usher on those changes over the next several months. Q: We just had this conversation sometime back with regards to what you all were expecting from the SEBI to come out with on the mutual fund industry. One of the things you spoke about was fundability and the tweaking of the overall expense ratio. Give us a sense in terms of what exactly would the fundability norms mean with regards to overall expense ratio and how is it going to help the mutual fund industry going forward?
A: The fundability basically means that previously you had an expense ratio cap and within that management fees were also capped. Now, what happens is that the expense ratio is increased a little bit but, more importantly within the expense ratio, there is no cap on the management fee.
Those asset management companies that are efficient within the same expense ratio can get more management fees through that efficiency. I think this will spur the entire industry to become more efficient.
_PAGEBREAK_ Q: You alluded to the fact that more is required. We need some more changes to attract inflows. What do you think should be done and what SEBI has not yet addressed which should be done?
A: I think one of the big issues that the industry faces is that there is no long-term money coming into the industry. When I say long-term money, it is the mandatory savings of individuals. There is no insurance money because asset management companies or investment management companies in India cannot manage insurance money.
I think what needs to change is that investors should have a choice. Today, only voluntary savings go into NPS. All mandatory savings go into the EPF. Firstly, I think investors should have the choice of either investing in EPF, NPS or a mutual fund that has the same regulatory structure as a pension fund.
Once that happens, mandatory flows will come into the investment management companies and I think you will manage more money. There will also be an element of stability because mandatory savings are typically for 15, 20 or 30 years. I think that's the big structural change that needs to be done. Q: Has that been put forward by you or the mutual fund industry to SEBI? What's been their response, any hurdles that you believe could be there?
A: I think that requires the intervention of the government and the ministry. We have placed our requirements with the ministry officials. We have informed them but, I think it has to be debated because obviously there are several constituents. The EPF is involved, the ministries are involved and I am sure several people, opinion makers, thought leaders would also like to comment on that.
But, definitely we have placed our request on that and hopefully, in the next few years or at least partly this year, I hope when the Budget is announced some of these measures will be introduced. Q: What are your thoughts with regards to this entire change on exit loads? Is it going to be more beneficial for long-term investors? Can you just take us through the rationale and your thoughts on it?
A: Franklin Templeton have always looked at exit load as a mechanism to kind of guide investors to stay invested in our funds for a longer term because the whole idea of investing we believe is long-term investing. For us, when people exited before the exit load period was never a mechanism to make money out of it.
We welcome SEBI's move to actually credit the exit load back into the funds for the benefit of existing investors. Often we find that when an investor leaves before the exit load period, especially large investors, it creates some problems for the fund managers in managing the fund.
For example on debt funds, if there is a huge redemption that was not anticipated then the debt markets are not very liquid. When you sell on that debt, there is a loss incurred. Who bears the loss? The investors who remain in the funds.
To the extent that the exit load goes back to the credit of the funds, I think it is for the benefit of existing long-term investors who are staying in the funds. I actually welcome that move.
_PAGEBREAK_ Q: What about the overall cost burden on an investor now because now the service tax goes to investors, how much of incremental increase do you see?
A: The 20 basis points increase in TAR(5.58) is neutral because the exit load will be credited back for the benefit of investors. The service tax is an additional expense. So whatever is the management fee, on that maybe 10 basis points, 12 basis points and in the smaller cities as you get investors from smaller towns obviously you can pay upto 30 basis points more if you get 30% of the investors from the cities outside the top 15.
That has an incremental cost of upto 30 basis points. But, I would urge you and urge our investors and the public at large to look at it slightly differently. At the end of the day, its maybe 30 basis points, 35 basis points incremental expense but what the mutual fund industry charges is very transparent.
Think about it, when you buy fruits and vegetables, does it ever occur to you that the farmer gets Rs 2 and you pay Rs 20. Property prices have gone up fivefold in the last 10 years; does anybody really say anything about it? For us the expenses are going up, effectively by 30-35 basis points and over an above that we are not getting some of the expenses like taxes. The taxes were always supposed to be borne by the end investor. Q: Given the fact that retail has already been out of the market for quite sometime now, the markets have been very volatile. For them to impose an additional cost, do you think retail investors will try and make a comeback? Do you see them coming in the near-term to invest in equities?
A: I think retail investors will come irrespective of the cost because the costs are insignificant. If you look at 10-15 years record of equity firms, many of them have given over 20% compounded. Another 25 bps is not significant.
There are two requirements for an investor to comeback. One is the general state of the economy, optimism and the business environment. I think that is an issue now. There have been concerns about the general business environment. Secondly, tax benefits, one of the big drivers of investments in mutual funds as mutual funds are subject to market risks.
On the other side, you have bank deposits giving you 8-9%, you have the small saving schemes giving you 7-8%, you have tax free bonds giving you 8%. We are competing against that. If you have the right tax incentives then you can draw investors into mutual funds and I actually believe, that's the second structural reform.
One is about long-term investments in pension and insurance companies and that is to be managed by the investment management companies. Secondly, the government needs to create a long-term investment scheme whereby you pay up to 5 lakh per annum. At the time you invest you save tax. Returns on that investment gets taxed as per DTC rules.
But, when you withdraw that money, you pay tax on it. It's only a tax deferral. So the government loses current revenues, but subsequently it gets those revenues back. That can be a huge driver of flows into the mutual fund industry. I think the second structural reform is to create those long-term investment plans, maybe with a 5 year lock-in and this will also help people save money for certain events like children’s education, marriage, all of which are big expenses these days. I think there has to be some tax incentive. Q: How do you play as a retail investor, I mean Indian macros looking very bad, globally there is some stability fund flows coming, in how do you play or how do you allocate your portfolio? Do you still put some amount in debt funds, should you venture it into equities at this point? There was an article in the newspaper today that there is a significant reduction in terms of F&P investments as well. Just give us a sense is the lure of debt coming off?
A: I don't think so. I still think that debt schemes of mutual funds are probably on post tax basis, probably they are the best for a retail investor because you can index your gains before paying taxes. So I think its still very good.
I personally believe that debt funds will not only survive but, will thrive and I feel that if an investor is not allocating a reasonable portion of their savings to debt funds, they are making a big mistake. As far as equity investment goes, I know there is a little bit of pessimism about the state of affairs in India and the markets.
But, let me give you a perspective, I travel to several countries in my role as Managing Director for Central East and Europe, Middle East and Africa and India still has probably the best growth amongst those countries. We are crying because growth is 6% and I think 6% is not enough to meet the aspirations of the people of India, we need maybe somewhere between 8-10%.
But, 6% is a lot better than 0% or negative growth. I would say that yes, there are difficult times but, even if you have 6% GDP growth, corporate earnings should be able to grow at maybe 12-15%.
_PAGEBREAK_ Q: One of the particular statements which have come down from the Finance Minister is that they don't mind or they would look to allow MFs to invest in the Rajiv Gandhi Equity Scheme soon. What would your thoughts be on that? It's a recommendation.
A: Obviously, that's a step in the right direction. I think the Rajiv Gandhi Scheme is a good scheme. But, getting first-time investors to invest directly in equities is a recipe for disaster frankly. The only way that should be implemented in my view is through mutual fund schemes so that they can get a diversified exposure to equities.
One other point is it's hard to actually monitor who is a first time investor. Rs 50,000 is not a lot of money these days. The government should withdraw that restriction and allow investors to invest 50% without having to do that check. Secondly, I think we should do Rs 50,000 per year, not one-time, because if you invest Rs 50,000 one-time you don't really get the flavour of the markets.
When you invest regularly over a period of time, that's when you really appreciate what are the rewards and what are the risks associated with a market. The best way to do it would be with mutual funds through SIPs across several years, for which the Rs 50,000 limit has to be a recurring annual limit. Q: From a sophisticated investor's perspective where do you stand on the growth defensives versus cyclicals debate? Do you think it's a good point to enter into the cheaper cyclicals? We have had a very decent rally. Would you look to raise your cash levels at this point and take some partial profits off the table?
A: The way we manage our fund is not to really take big cash calls. People invest in equity funds because that is their asset allocation that their advisors have made with them. So it's up to the advisor jointly with the investor to decide whether that asset allocation is right or needs to be changed. We don't take significant cash calls. Our cash is typically in the 5-7% range and that's what we intend to keep it.