On April 28, the capital market regulator, Securities and Exchange Board of India (SEBI) issued a circular regulating fund manager compensation. The new rule makes it compulsory for top officials of mutual funds to invest 20 percent of their salaries in their own schemes. The idea behind the move is that some fund houses take excessive risks while chasing returns, thus possibly jeopardizing the prospects of schemes managed. SEBI wants to make sure that the interests of the fund managers are aligned to those of the unitholders. The question is: Will this lead to better fund management and better returns?
What portion of a fund manager’s salary is to be invested in schemes of the same house?
The new rule says 20 percent of a fund manager’s salary is to come by way of mutual fund (MF) units that he/she manages. The salary is the gross annual CTC (cost-to-company), less income taxes paid and statutory contributions such as Employees’ Provident Fund and the National Pension Scheme. The 20 percent threshold is just the minimum. MFs are free to fix a higher threshold.
Are fund managers the only employees whose salaries will get affected?
No, there’s a whole bunch of people that SEBI has identified who will need to comply with the new rule. All those employees who are classified as ‘key officials’ would come under this new rule. These include the chief executive officer (CEO), chief investment officer, chief risk officer, all the department heads who report to the CEO directly, and the fund management team, including the research group and dealers.
Who will decide the scheme to be allotted and the pattern?
This depends on who the key official is. Let’s begin with fund managers. At the very least, they have to now invest in the schemes that they manage. If they manage two or more schemes, then the 20 percent of their salaries would need to be invested in these schemes, in proportion of the scheme sizes. The larger a scheme’s size, the higher will be the fund manager’s investment in it. If a fund manager manages just one scheme, then she can invest her entire 20 percent corpus in that one fund. Or, she can spilt the amount between her own scheme and any other fund, whose risk profile is equal or higher.
All categories have only one scheme per fund house. But there are some categories where there is more than one scheme – thematic and solutions-oriented funds, for example. If a fund manager is in charge of multiple schemes in such categories, she can invest half of her 20 percent kitty in own schemes and the other half in funds of other categories. Here again, the new category’s risk profile has to be the same as the one she manages, or higher.
What about the compensation of other senior officials?
Here’s where it gets tricky. All of an asset management company’s (AMC’s) key officials, except fund managers, research analysts and dealers, encompass all of the fund house’s schemes. SEBI’s 20 percent rule says that it will have to invest in all of the fund house’s schemes. Only passively-managed schemes such as exchange-traded funds, and index, overnight, as well as closed-end funds are removed from this list.
Still, for large fund houses, the number of investment-allowable schemes is large. For instance, SBI mutual fund, India’s largest fund house with assets worth Rs 5.04 trillion has 46 schemes. ICICI Prudential mutual fund manages 61 schemes. Aditya Birla Sun Life mutual fund manages 57 schemes, which would qualify as those in which their senior fund officials must invest 20 percent of their respective salaries. In other words, their own investment portfolios would now have as many schemes, in addition to their existing investments.
But what if fund officials sell their mandatory unit holdings immediately after they are allotted?
No, that is not possible. As per the rule, there is a lock-in of three years the moment 20 percent of their salaries get invested in these schemes. Only if the funds are wound up before that can they get their money back. But after the lock-in period expires, they are free to redeem if they want to.
Also, this is going to be an annual ritual. Every year, the top fund official’s 20 percent salary would be invested in these funds. And all such investments will be subject to the three-year lock-in. This arrangement will go on for as long as the fund manager or any other “key official” is employed with the fund house.
What happens if your fund manager or any other official is found guilty of wrong-doing?
If found guilty, the ‘key official’ will lose the units. The fund house will sell the units and credit the redemption proceeds back to the scheme. In other words, the top official will lose his money.
SEBI appears to have deliberately inserted this condition as there have been some instances of front-running in mutual fund houses that have come to light. That is also why dealers have been included in this rule. “The recent Franklin Templeton case also seems to have nudged SEBI to lock away a portion of the fund official’s salary,” says a senior mutual fund industry official who did not wish to be named.
Some fund houses have complained that the asset allocation of fund houses will get skewed. An equity fund manager who manages only one scheme or category is allowed to diversify, but in only those schemes that are classified as carrying equivalent or more risk.
That is partly true. As per CRISIL, just four open-ended equity funds (aside from closed-end schemes, ETFs and index funds) are classified as ‘moderately high risk.’ Five other schemes are ‘high’ risk. All the other equity schemes are classified as ‘Very high’ risk; the highest risk classification as per SEBI’s revised risk-o-meter guidelines. Equity fund managers who take care of schemes classified as ‘moderately high’ or ‘high’ would still be able to diversify among debt funds as some are classified as ‘high risk’ and ‘very high risk’. To be sure, most of these debt funds are credit risk funds.