How to analyse the scope for high-risk MF products

The SEBI is said to have been concerned with the growing investors in rushing to earn higher returns are exposing themselves to higher risk Portfolio Management Services and even at times falling in the trap of unregistered advisors

In continuation of the market reforms and product innovation, the Securities Exchange Board of India (SEBI) has proposed a new mutual fund (MF) category in the last fortnight. In a bid to ease and simplify the selection of funds offered by the Asset Management Companies (AMC), the regulator, in 2018, has come up with fund categorisation, a broad set of classification made on the nature or objective of the fund. This has greatly enhanced the experience of the investors in identifying and differentiating/ comparing two funds.

The regulator has written a new proposal to the Association of Mutual Funds in India (AMFI) seeking views on a new fund categorisation. The AMFI is a non-profit organisation, which is an association of all the 45 AMCs operating in India. The proposed category will cater to investors with a high-risk appetite and will have a higher minimum investment. It will also have relaxed norms to generate high returns.

The SEBI is said to have been concerned with the growing investors in rushing to earn higher returns are exposing themselves to higher risk Portfolio Management Services (PMS) and even at times falling in the trap of unregistered advisors. So, by launching a high-risk MF product, investors could largely be in the purview of the tightly regulated products, countering the risk of the investors.

The category of schemes could possibly have a higher flexibility in managing their funds unlike the current set of regulations for the MF. Still at a consolation stage, the proposal is to allow these funds to dabble in momentum stocks across the market caps (ie, large, mid, small and even in micro), employ derivatives and other high-risk leverage strategies along with investing in high-yield junk bonds or long-short strategies to achieve higher returns to the investors.

Currently, these said high-risk strategies are permitted through PMS and Alternate Investment Fund (AIF) categories with relaxed norms of management of the funds. Though they do come under the various regulations of PMS and AIF laws, they have a higher leeway than that of the highly restricted MF categories. The minimum threshold for investment in these funds is currently at Rs 50 lakh and Rs 1 crore respectively for PMS and AIF.

The higher threshold for these funds limits the retail investors to participate however, the greed to earn higher returns is making them fall prey to unsolicited, unregistered and unregulated pseudo-advisors (fin-fluencers, etc), putting their invested corpuses at risk of losing altogether.

Instead, the new proposal allows gaining exposure to these charms but at a regulated pace, distributed through regulated entities, ensuring control over the entire transactions. The consultation elicits responses from the AMFI on the aspects of relaxation to be allowed to run these funds and the minimum ticket size for these set of funds.

Though this proposal is bold, it could allow the retail investors to taste the possibility of higher returns and explore complex investing strategies while taking safeguard from the MF regulations, overall gaining from the best of both worlds.

The proposal seems to have met with mixed reactions of excitement and apprehension. The underperformance or possible losses incurred due to these investment strategies could have a negative drubbing on the perception of the other products as well as the brand (reputation built over a long period).

Also, despite the higher threshold, wouldn’t always translate into better screening of the investors leading to losses and bad investor experience. Certainly, as the market matures and MF industry deepens, there could be a possibility for a product filling the large gap between the vanilla MF and other alternate products. But the regulator has a tight rope to balance to get this category right.

(The author is a co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])