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R. Viswanathan

IN THE flurry of takeovers of mutual funds in India, are the investors getting a raw deal? Put differently, are the asset management companies (AMC) that sell their companies to others unduly gaining at the expense of the hapless investors? Such uncomfortable issues have not so far been raised in India possibly because the reported takeover deals have not been scrutinised by independent experts. It is time to focus on one aspect of these deals, which is patently exploitative in nature.

To be fair, in all the AMCs that are sold to a new management, the expectation, based on facts, is that the new management will manage the funds better and this will benefit the investors. But, in the process, it is debatable if the old management deserves the amount that is being paid to it. Of the transfers concluded, so far, two pertain to one partner in AMC buying out another. In the deals concluded so far, the new owner of the AMC would have paid a sum — which is more than the financial worth of AMC — to the old owners. The reason for the premium is that the old owner had generated some goodwill, which needs to be compensated. Is this valid, especially because the management changes only due to the incompetence of the old owner, who is not able to carry on the business?

One might ask whether such goodwill is not paid by many purchasers of even badly-managed companies. But, then, AMCs are totally different from industrial and even banking companies.

An AMC is just an agent of the multitudes of investors who put their money into its care. The crucial difference between an AMC and a bank is that in the latter, money is borrowed, whereas in a mutual fund, the AMC takes the money just for management. That is why, if a bank loses while investing the money, the depositors should not be affected: The banks are expected to keep at least 10 per cent of their total loans as share capital, so that even if there is a loss of 10 per cent, the depositors are protected. Further, world-over, governments afford protection to depositors in the form of deposit insurance; in India, a depositor is insured up to Rs 1,00,000 per bank.

In a mutual fund, the entire risk of investing falls on those subscribing to the fund. The AMC is just an agent for all the investors: If the fund loses on investment, the AMC is not responsible, unless gross negligence is proved. And, in a famous case, the giant, Unilever, reportedly took a prominent AMC to task for alleged mismanagement of its pension fund. In India, of course, such instances are absent and even if some investors sue an AMC, the legal process can be extremely time-consuming.

Historically, mutual funds gained currency when people felt that banks were making undue gains by collecting deposits and granting loans: It was claimed that depositors were paid low interest and borrowers charged high. Many felt that if banks are bypassed, and savers and investors got in touch with each other, both would benefit. Savers could get a better yield for their savings and borrowers funds cheaper. This, in a nutshell, is called disintermediation.

Disintermediation appears simple in theory, but could be complex in practice. For, it is physically impossible for people with funds to pool the resources and centrally invest the money, without assistance from experts. Thus evolved the agency companies called asset management companies whose role is, in theory, to assist the investors in wisely investing a pool of funds. Typically, instead of investors a going in search of an AMC, the latter went looking for investors. Thus, an AMC will think of collecting money for a mutual fund and float an investment scheme. Anyone desirous of contributing is invited to do so. While floating the scheme, the boundary rules for investment — whether in shares or bonds — — and the management objectives of the AMC are clearly spelt out.

The regulator — SEBI — oversees the functions of the AMC barring, of course, the UTI which is also to be brought under SEBI's purview soon. Further, to ensure that the AMC does not stray away from the narrow path outlined in the objectives of the scheme, a Board of Trustees is appointed to supervise the AMC's functions.

Thus, the AMC is the agent and the trustees the representatives of the multitude of investors. In practice, the trustees are nominated by the AMC itself, creating the same kind of conflict of interests seen in auditors being appointed by management of companies, giving rise to some glaring malpractices, like in the Enron debacle.

Many AMCs manage a number of mutual funds. When an AMC is unable or unwilling to continue to manage them, it invites another AMC to take over the functions. While doing so, the new owner pays some money, which is in excess of the financial worth of the selling AMC.

The main reason for paying the premium is that the new owner expects to make profit in the transaction. And the profit can come only out of the money, in the form of management fees, to be paid by the investors (fund owners) in the future. One more reason is that the new owner gets a large captive investor group, to whom it can sell its other products; this is, however, a remote possibility.

Let us take a concrete example. An AMC mismanages the mutual fund and wants to sell its stake. Another AMC takes over. The payment made by the new owner is typically related to the total funds under management. For example, with funds aggregating Rs 200 crore, the new owner will pay 0.5-1 per cent of the sum — Rs 1 crore or Rs 2 crore. This sum would, obviously be recovered from the fund owners over the next few years by the new owner.

Surely, one would ask: Can the transfer take place without the knowledge and consent of the investors in the mutual fund? The answer is yes. The investors will be asked, but the persons who should examine the implications are the Board of Trustees, who are the authorised representatives of investors. Thereby hangs another tale.

Conceptually, the trustees are supervisors of the AMC, whereas in practice, they are virtually appointed by the AMC. In fact, in many AMCs owned by public sector enterprises, the sponsoring enterprise itself is the principal trustee. Can any arrangement be more promiscuous than this. In the early stages of evolution of the mutual fund concept, this was permitted, but it is time the practice is changed for the better.

Even if the new owners of AMC do not charge higher fees than the old ones, the question is to whom should the premium paid by the new AMC go. Logically, it should go to the investors; on the principle of agent-principal relationship, if an agent is fired by the principal, the new agent might agree to a lower commission and, in any case, it should not make any `severance' pay to the outgoing agent.

In all the deals done so far in India, this principle has been given the go-by. The result is that the AMC, which mismanages, gets premium for its past deeds and the new one pays the premium from the fees to be charged to the investors in the future.

The existing practice needs to be debated widely and examined in depth by the SEBI so that those who invest in mutual funds do not indirectly reward the AMC that mismanged their funds. Also, the trustees for mutual funds should not, in any way, be connected with the owners of the relative AMCs.

(The author is former Deputy Managing Director, SBI.)

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