For years Moneylife magazine has been panning bizarre new fund offers. Now the market regulator takes a hard stance on them, especially capital-protection schemes, which it had defended four years ago

For a number of years, capital markets watchdog Securities and Exchange Board of India (SEBI) seemed to be unconcerned about the quality of New Fund Offerings (NFOs). In the boom of 2005-07, fund companies launched a flurry of NFOs, which were pushed with the help of juicy commissions. Many were criticised only in Moneylife magazine while SEBI officials probably believed in laissez faire. In fact, when a capital protection fund was launched in late 2006, we had written against the concept, which drew a letter from SEBI, a rare occurrence.

After turning a blind eye to the heady concoctions of the mutual fund industry all these years, SEBI now seems to be in a mood to act. Perturbed by the increasing complexity of new mutual fund schemes waiting for its approval, SEBI has asked several companies to go back to the drawing board, according to media reports. SEBI has particularly taken a critical look at capital protection oriented schemes, according to an article in The Economic Times.

This is interesting because, four years ago, in an article titled "Fake Claim", we had written: "In the 1990s, there were mutual funds that offered guaranteed returns. Every single one of these funds lost a substantial part of capital.  Amazingly, the regulator, Securities and Exchange Board of India, is allowing mutual funds to revisit the '90s and make a similar pitch now. This time, they are called Capital Protection funds. Fund companies are watching each other like a hawk, with the hope of duplicating each other's ideas and, therefore, four capital protection ideas have been filed with the regulator, two by Reliance and one each by Franklin Templeton and HDFC." 

We had argued, "A true capital protection fund should protect the entire capital invested with the fund under any circumstances. Is this possible? The fact is, there is simply no tradable security, except very short-term cash equivalents, which can guarantee capital protection. Equities can lose a lot of value very quickly. But even the best of bonds can lose value when interest rates go up. So, theoretically, the claim of capital protection that these funds are making is false."

One such capital protection fund we discussed (of Franklin Templeton) injected further uncertainty into the whole process by saying that the "asset allocation pattern mentioned above is not a steady state pattern; it is the allocation pattern for the initial deployment of funds collected in the respective Plans during the New Fund Offer. This means even the theoretical construct of capital protection is not well-laid beforehand! We wonder how SEBI agreed to clear these ideas," we wrote.

One other capital-protection scheme, from Reliance Mutual Fund, could theoretically make an investment of 70% in equities and 30% in debt. We pointed out, "It becomes an equity fund. Surely, it would be ridiculous to expect an equity fund to offer capital protection. But that is what Reliance Capital Shield is offering and SEBI has cleared it! Worse, SEBI has allowed these funds to even take positions in equity derivatives-the riskiest segment of the market-even though their main objective is capital protection."

Capital-protection schemes were among the many schemes that were launched in the previous boom with the sole objective of gathering assets. Moneylife was the only publication to have pointed out holes in different kinds of funds.

Indeed, the Moneylife analysis of best fund houses is based on a four-factor model, in which fund houses get a negative weight for launching too many schemes. We even analysed how badly these fancy schemes perforrmed in a cover story titled 'Fancy Funds, Average Returns.'

After four years, SEBI has now found that in many NFOs, these schemes are either too complex for the tastes of average investors, their strategies involve substantial risk or that their names would create confusion in the minds of investors. You wish SEBI were more proactive then. In fact, SEBI was in a mood to side with the industry-and not investors.

After our article was published, the letter from SEBI argued that we had made baseless allegations. Its only lame reason: "A higher proportion of debt securities (especially secured debt instruments) normally stand to guard against capital erosion vis-a-vis equity instruments that are more prone to market forces. Thus, the strategies chosen by some of the fund houses are, prima facie, not questionable." 

Clearly, SEBI was not willing to bother about a situation where the debt part loses value and the "capital-protection" falls apart.

Moneylife had replied to SEBI saying that that "the English meaning of 'capital protection' is just that and it can come about only when a portfolio is completely insulated from the ups and down of securities. The fund industry assumes that both equities and debt will go up forever. Templeton's advertising hoardings also convey this impression to the investors. Surprisingly, SEBI subscribes to this view too. It is interesting to note that four years later SEBI has woken up to the ills of fancy NFOs, including that of capital-protection ones."

For long, NFOs have been the quintessential 'cash-cow' for fund companies, who have milked the same quite generously to pile up more assets under management (AUM). Particularly, the boom period leading up to 2007 witnessed frenzied activity as asset management companies (AMCs) churned out a flurry of NFOs in a bid to capture volumes in a rising market scenario. However, this largely came at the expense of product and service quality.

It has taken a long time for SEBI to wise up. Over the last four years, Moneylife has written numerous articles about the various strategies adopted by fund companies to grab investors' attention. Fancy product names, complex strategies, new product launches during a market rally etc were quite the norm in the industry. Fund companies were actively encouraging distributors to advise investors to sell their existing funds and subscribe to NFOs. They shamelessly enticed investors with the logic that NFOs were priced at Rs10-supposedly much cheaper-than-existing units-when actually the issue price of NFOs is meaningless.

The fact remains that SEBI supported the fund houses during this period by allowing shoddy offer documents to pass through its doors unchecked. Some would even argue that SEBI was a willing participant in this situation. A distributor recently commented on our website, "Of course, AMCs have played a big role by bringing out redundant NFOs but all of them have been sanctioned by SEBI and have SEBI's blessings. As long as the going was good SEBI was not bothered but when markets corrected, SEBI and AMCs shifted blame to IFAs (independent financial advisors), who were an easy target".

In the meantime, thousands of investors have fallen prey to the poorly conceived schemes floated by fund companies. It would have been better if SEBI felt 'concerned' about investors long ago, especially when there were repeated reports by Moneylife pointing out the abuses as they were happening.