Programme on Primer on Securities Markets Mutual Funds...

Programme on

Primer on Securities Markets

Mutual Funds and Alternate Investment FundsDr. Jinesh panchali

16th January 2014

Indian Institute of Corporate Affairs

Only for private circulation; IICA Programme 15-16 January, 2016

Contents: Going public and private

Two broad category of fundsRationale for regulation

Mutual FundsBroad issuesStructure / Investment restrictionsTypes / Accounting / Taxation / Change in AMC

Alternate Investment FundsMeaning / Registration / CategoryEligibility / Investment conditionsInvestment conditions (General and specific)Angel InvestorsGeneral obligations

Statistics


Two category of funds

Mutual funds

Invest in liquid / public domain

Promotes retail participation

Alternate Investment Funds

Invest in private domain

Highly specialized and risk oriented

Why SEBI to regulate AIF where public / Retail investors are notinvolved.


Mutual Funds: Broad issues

Mobilises Household savings in organised markets

Strong force with equity / control: Stabilizing agent

Institutional Investors activism

Cascading Agency issue

Areas of conflict of interests

Issues in (mis)marketing of these funds


Mutual Funds: Trustee : Variables

Mutual Funds

Transparency

Liquidity

Expertise

CostRisk

Regulation

Variety


Mutual Funds: Structure

Sponsor

Trustee

AMC

Fund

Schemes

Investors

Other Serviceintermediaries

Regulator

Investee companies/ Funds


Mutual Funds: Sponsor

Sponsor is a person (an entity) who sets up a Mutual FundSponsor

1. settles the Trust,2. makes initial contribution for setting up the Trust3. executes Trust Deed with the Trustees4. appoints the Board of Trustees5. owns minimum 40% of share holding of AMC

Sponsor

1. Must have positive net worth

2. Minimum 5 years’ track record

3. History of positive After Tax Profit for 3 out of 5 years including fifth year

4. Must be a ‘Fit and Proper’ person


Mutual Funds: Trustee

1. The Mutual Fund set up as Trust, is managed either by a Trust Company or a Board ofTrustees

2. The Board of Trustees and Trustee Company are governed by the Indian Trust Act, 1882

3. The Trustee Company is also subject to the provisions of the Indian Companies Act.

4. It is the responsibility of the Trustees to protect the Interests of the Investors / Unitholders

5. The AMC and other functionaries of Mutual Funds are functionally accountable to theTrustees

6. Trustees have to exercise General Due Diligence and Specific Due Diligence. Specific DueDiligence includes obtaining compliance certificates at regular intervals, etc.


Mutual Funds: Trustees

Trustees are

1. appointed by the Sponsor with SEBI approval

2. At least 2/3rd Trustees must be Independent

3. liable to investors for acts not done in good faith and if they have not exercised

adequate due diligence

4. approve each MF scheme floated by AMC

5. the registered owners of Fund Assets

6. Trustees receive fees for their services


Mutual Funds: Trustee : Eligibility

Person of high repute and integrity

Not convicted for economic offence under securities laws

Trustee cannot be a part of AMC as Director, Employee or Officer of the AMC

Trustee of one Mutual Fund cannot be a Trustee of another Mutual Fund.


Mutual Funds: AMC

Trustees appoint the AMC if so authorized by the Trust Deed with approval of SEBI

AMC is constituted as a Company under the Indian Companies Act

AMC has to maintain net worth of not less than Rs. 10 crores at all times

At least 50% of Directors of AMC to be independent directors


Mutual Funds: AMC

AMC can do only the following businesses

Asset Management Services

Portfolio Management Services

Portfolio Advisory Services

AMC can be terminated/changed with the consent of

Majority of Trustees

Unit holders representing at least 75% of Unit Capital

With prior approval of SEBI


Mutual Funds: AMC

AMC is the Fund Manager for managing Mutual Fund Assets

AMC prepares different MF schemes which are approved by the Trustees

AMC accountable to the Trustees

AMC charges Asset Management Fees subject to ceiling prescribed by SEBI.

There is an Asset Management Agreement between AMC and Trustees


Mutual Funds: Custodian and R&T

Custodian

SEBI registered entity

Appointed by Trustees

Keeps records and account of securities / investments

Collects benefits under investments

Sponsor & custodian cannot be same entity

Registrar and Transfer Agent

SEBI registered entity

Appointed by Trustees

Keeps record of unit holders account

Issues, redeems, transfers units of mutual fund schemes

R & T agent is a separate entity


Mutual Funds: Others

Stock Exchanges

Depository

Depository Participant

Brokers

Distributors / Advisors / Relationship network


Mutual Funds: Regulators

Ministry of Finance / Ministry of Corporate Affairs

Reserve Bank of India: (To an extent it relates to Money Market/ Call money

/ Out bound and Inward Investment

SEBI Mutual funds

All registered entities

ROC / MCA: All company law related material (AMC / TC)

Mutual Fund Trustees are accountable to Public Trustees for compliance

with Indian Trust Act 1882

Charity Commissioner is the overall head for all Public Trusts


Mutual Funds: Types

Closed ended

Open ended

Interval (not popular now)

Exchange traded

Fund of Funds


Mutual Funds: Types

Equity: Sectoral / Small – Mid – Large cap /

Debt: Variety include Gilt, MMMF, FMP/ Corporate Bond/

Tax saving

Hybrid: Balanced / Debt plus equity

Thematic

Index / Inverse Index

International Funds

Gold (commodity funds)

Capital Protection Fund

Real Estate Investment Trust

Other Alternate Investment Funds


Mutual Funds: Investment restrictions

No scheme shall invest more than

15% of its NAV in debt instrument of single issuer which are not rated belowinvestment grade

10% of its NAV in unrated debt by single issuer and total shall not exceed25%of NAV (All such investment should have specific approval of Board ofTrustees and AMC)

(credit and concentration risk management)

No MF under all its scheme owned NMT 10% of any company’s voting rights as

(control dynamics)

MF should invest not more than 10% of NAV of its any scheme in equity of anycompany

(concentration risk)


Mutual Funds: Trustee : Investment restrictions

No fund shall make any investment in Unlisted | privately placed security of anassociate or group company of sponsor and in Listed securities exceeding 25%

(governance and conflict of interest)

No MF scheme shall invest more than 5% (open ended) / 10% (closed ended) of itsNAV in any unlisted equity

(liquidity risk)

Transfers from one scheme to another scheme is allowed only if it is in sync with

Investment objective and at spot | prevailing market price | fair price. Inter-scheme investment should not be more than 5% of NAV of scheme

(Governance and conflict of interest)

No MF shall invest in Fund of funds


Mutual Funds: Trustee : Investment restrictions

Invest only in delivery based transactions

MF cannot invest in carry forward transactions, derivatives, and short sellingtransactions. It can hedge its portfolio using derivatives.

(avoid speculation)

Mutual funds cannot borrow, except to meet temporary liquidity demands for thepurpose of repurchase or redemption of units, or payment of interest or dividendsto unit-holders.

The amount of any such borrowing shall not exceed 20 per cent of the net assets ofthe scheme and the duration of the borrowing shall not exceed six months.


Mutual Funds: Trustee : Investment restrictions REIT

Every RIET scheme to invest NLT 35% of Its NAV directly in real estate assets

Every REIT scheme has to invest

NLT 75% of its net assets in

real estate assets

mortgaged backed securities

securities of the companies engaged in real estate business orundertaking projects, whether listed on a recognised SE in Indiaor not

Unless otherwise disclosed in offer document, no mutual fund can under all itsREIT schemes, invest more than 30% in single city

NO Fund under all its schemes invest more than 15% of its net assets in any singlereal estate project: a project by a builder in a single location within a city


Mutual Funds: Trustee : Investment restrictions REIT

No MF under all its RIET scheme invest more than 25% of paid up capital of anyunlisted company

As well, NMT 15% of scheme Net assets in any securities of any unlisted company

REIT schemes cannot invest in its

any unlisted securities of sponsor or associates

any listed securities of sponsor or associate in preferential allotment

any listed securities of sponsor or associate in excess of 25% of its NAV

REIT MF is not permitted to transfer real estate assets amongst its schemes

MF cannot invest in real estate assets of sponsor or AMC


Mutual Funds: Trustee : Investment in derivatives

Cumulative gross exposure should not be more than 100% NAV of scheme

Shall not write options

Total exposure to option premium paid should not be more than 20% of is NAV


Mutual Funds: Trustee : Expenses

All expenses to be clearly identified and appropriated to the individual schemes

Limits of the total expenses of the scheme including investment and advisory fees

Fund of funds 2.5 % of average daily NAV

Index funds 1.5% of average daily NAV

Other schemes

First 100 crores 2.5%

Next 300 crores 2.5%

Net 300 crores 2%

On the balance 1.75%

For debt schemes, these expenses to be lesser by 0.25%

For brokerage and transactions costs 0.12 % cash segment transactions

0.05% for derivatives segment

Any expenses other than those which are specifically provided by in regulation to be borne by the AMC


Mutual Funds: Trustee : Few Terms

Net Asset Value

Accounting on Marked to Market basis

Accounting on Accrual basis

Investors Services

SIP, SWP

Liquidity and Diversification


Mutual Funds: Taxation

Equity oriented fundsMore than 65% in equity

Dividend tax free

No dividend distribution tax at fund level

No capital gain tax except short term at 15% (one year)

Other fundsDividend is tax free

Distribution is subject to dividend distribution tax at fund level

Short term capital gain is taxed

Long term capital gain: with indexation and without indexation


Mutual Funds: Takeovers

AMC Take-over by new Sponsor:

Trustees approval required

SEBI clearance required

Unit holders to be informed and exit option

Alliance MF taken over by Birla MF

Scheme Take-over:

Scheme of one Mutual Fund taken over by another Mutual Fund

Trustees approval required

SEBI’s approval required

Unit holders informed & can exit without exit loads

Amendments to Trust Deed, Offer Document, AMC Agreement may become necessary

Schemes of Zurich MF acquired by HDFC MF


Real Estate Investment Trust: Why

1. Defensive Asset class: Behaves differently from debt equity and gold

2. Help Diversification

3. Relatively less volatile

Direct investment in real estate poses limitations

1. High transaction value

2. High transaction costs

3. High administration costs

4. High regulatory risk

5. Low liquidity

6. Lack of transparency in pricing and problem of unaccounted money


Real Estate Investment Trust: Real estate

1. They invest in real estate

2. Located In India

3. Valid title and other documents

4. Legally transferable

5. Free from encumbrances

6. Not subject to any litigations

Does not include:

Project under constructions

Vacant land

Land specified for Agriculture


Real Estate Investment Trust: Necessities

The sponsor should have a sound track record and general reputation offairness and integrity in all his business transactions.(i) be carrying on business in real estate for a period of not less than five years;

and

(ii) the networth is positive in all the immediately preceding five years; and

(iii) the networth in the immediately preceding year is more than the capitalcontribution of the sponsor in the asset management company; and

(iv) the sponsor has profits after providing for depreciation, interest and tax inthree out of the immediately preceding five years, including the fifth year;

The applicant is a fit and proper person;

In the case of an existing mutual fund, such fund is in the form of a trustand the trust deed has been approved by SEBI;


Real Estate Investment Trust: Who can promote

The sponsor has contributed or contributes at least 40% to the net worth of theasset management company:

The sponsor or any of its directors or the principal officer to be employed by themutual fund should not have been guilty of fraud or has not been convicted ofan offence involving moral turpitude or has not been found guilty of anyeconomic offence;

Trustees are to be appointed for the mutual fund;

Asset management company is to be appointed to manage the mutual fund andoperate the schemes;

Custodian is to be appointed in order to keep custody of the securities or otherassets or title deeds of real estate of the mutual fund, and provide such othercustodial services as may be authorised by the articles


Real Estate Investment Trust: Scheme features

1. Close ended

2. Redemption in staggered manner

3. Can not carry out lending or house financing activities

4. Transactions thru banking channels / cash transactions notpermitted

5. Determination of Net Asset Value

6. Other detailed investment restrictions for governance /concentration/

7. No ownership right to unit holders over the assets

8. Income arise from capital gain and lease rentals


Real Estate Investment Trust: Scheme features

The real estate assets held by a real estate mutual fund scheme areto be valued

o at cost price on the date of acquisition; and

o at fair price on every ninetieth day from the day of its purchase.

Valuation based on independent valuer system: 2 for every property/ NMT 2 years on same property / gap of 3 years

Daily NAV (capital gain and income accrued)


Mutual Funds

Income 56 77000

Equity 20 27500

Balanced 2 2750

Liquid 16 22000

GILT 1 1375

ELSS 3 4125

Gold ETF 1 1375

Other ETF 0.5 687.5

FoF and IF 0.5 687.5

100 137500

Souce: ISMR,2014 $ mn

Unit Holding Pattern %

Category 2012-13 2013-2014

Individuals 45.73 45.1

NRI 4.7 3.8

Institutional 49.57 51.1

Souce:

ISMR,2014 100 100


Mutual Funds

Net Flow and AUM (Rs. Crores)

Years Mobilisation Redemption Net AUM

2010-11 8959515 8909000 50515 592000

2011-12 6819679 6842000 -22321 587000

2012-13 7267885 7191000 76885 702000

2013-14 9768000 9714000 54000 825000

2014-15 11086260 10982972 103288 1082757

2014-16 7931919 7716460 215459 1324165

Source: SEBI, ISMR,2014


Alternate Investment Funds: Meaning

Formation:Trust; company, LLPNot covered under SEBI Mutual Fund and CIS Regulations

IncludeHedge FundInfrastructure fundVenture Capital funds and VCU

VCU not to be in NBFC / gold finance / specifically not permittedPrivate equity fundsSME fundsSocial Venture Funds and Social Venture

Public charitable trust; micro finance institutions / Sec 25companies/ societies for promotion of science literature and finearts


Alternate Investment Funds

Registration is necessary for all existing entities in business of AIF

(Application in six months)

Special case of VCF which are registered with SEBI


Alternate Investment Funds: Category

Category I:

Start up / early stage venture / social venture or SME orinfrastructure

Which Government feel socially and economically desirable.

Category II: Residual – those do not fall under I and III

PE funds / debt funds

Category III

Complex / risky / short term returns / leverages


Alternate Investment Funds: Eligibility

Fit and Proper

Necessary qualified and experienced sponsor and managers ofrespective entities

Incorporation documents

Should not be earlier refused / rejected by SEBI

Necessary infrastructure

Clearly defined investment objectives, audience, profile, strategy etc.


Alternate Investment Funds: Investment conditions

Outline the purpose, strategy, methodology and placementmemorandum

Any material alteration 2/3 mojority

Raising funds : Indian or foreign

Corpus: NLT 25 crores

Each investor: NLT one crore

Manager or Sponsor to have continued interestFit and Proper ( lowerof 2.5 % of corpus or 5 crores )

No. of investors: Not more than 1000

Solicit funds: Only by way of private placement


Alternate Investment Funds: Process of raising

Through private placement memorandum

Providing truthful and fair disclosures

Various schemes under the Fund

Category I and II : NLT 3 years; close ended; extensionwith 2/3

Category III: open ended or close ended

Listing is allowed after closing and minimum lot is 1 crore


Alternate Investment Funds: General Investmentconditions

• Invest as per strategy provided

• Coinvestment of Manager or Sponsor is allowed but not on morefavourable terms than investos

• Cat I and II, NMT 25% of investible funds in one company

• Cat III: not to invest more than 10% in one company

• Not to invest in associates except with permission of 75%

• Uninvested money in highly liquid investments



• Category I:VCF

• Shall not borrow : temporary requirements for NMT thirty days/ and not NMT10% of IF (Investible funds)

• NLT 2/3 in unlisted entity

• NMT 1/3 including in eligible entity’s IPO / debt / preferential /

SME: NLT 75% in eligible SME

SVF: NLT 75% in eligible SV

Infrastructure Fund : NLT 75% in eligible investments



• Category II:Primarily in unlisted securities

Private Equity Funds

Category III

Primarily in listed or unlisted or derivatives and complex products

Can invest in Funds of Cat I and II

Adequate Disclosure and time to time reporting to investors and theBoard



• Angel FundsDefinition of Angel

Minimum 2 cr tangible networth

Professional experience for 10 years /

early stage investment experience/

serial entrepreneur

If , Company then networth of Rs. 10 cr.

Registration is necessary



• Investment in Angel FundsCorpus of 10 cr

Term of fund maximum of 3 years

Minimum investment 25 lakh from per angel investor

Only through private placement

Scheme level restrictions

Not more than 49 angel investors



• Investment restrictions on Angel Funds/ schemeInvest in VCU which is NLT 3 year old

Having turnover of NMT 25 crores / if floated by Group then 300 cr

Investment in any company NLT 50 l and NMT 5 cr.

Locked in for 3 years

NMT 25% in one company

No to invest in associates


Alternate Investment Funds: General Obligations

Proper management

Transparency

Reporting to investors

Valuation

Maintenance of record

Reporting to Board

Dispute resolution


Further references1. SEBI regulations related to Primary markets and Mutual funds

All these Regulations, including the following regulations amended up to 2015 can be accessed from:

http://203.199.247.102/cms//sebi_data/Regulations.html

Website of sebi: www.sebi.gov.in

2. Handbook of statistics on Indian securities markets (year wise 2004-2014)

http://203.199.247.102/sebiweb/home/list/4/32/0/0/Handbook-of-Statistics

2014 Handbook:

http://203.199.247.102/cms/sebi_data/attachdocs/1434443549912.pdf

3. Indian securities markets, A Review: NSE publication

Full publication: http://www.nseindia.com/research/dynaContent/ismr.htm

Primary markets: http://www.nseindia.com/content/us/ismr2014ch2.pdf

Collective Investment

schemes (Mutual funds) http://www.nseindia.com/content/us/ismr2014ch3.pdf

Takeovers http://www.nseindia.com/content/us/ismr2014ch4.pdf (page no. 59)


http://203.199.247.102/cms/sebi_data/Regulations.html













http://www.sebi.gov.in/












































http://www.nseindia.com/content/us/ismr2014ch3.pdf
























Further references

4. National Institute of Securities Markets

Website: www.nism.ac.in/

Work book for NISM Series IX: Merchant Banking Certification Examination

Workbook for NISM Series V-C: Mutual Fund Distributors (Level 2) Certification Examination

5. Websites of Association of regulators/ members / mutual funds

International Organisation of Securities Commissions: https://www.iosco.org/

(Association of international securities markets regulators)

National Stock Exchange of India www.nseindia.com/

Bombay Stock Exchange www.bseindia.com/

Association of Investment Bankers of India: http://aibi.org.in/

Association of Mutual Funds in India: https://www.amfiindia.com/


https://www.iosco.org/







http://www.nseindia.com/





http://www.bseindia.com/







http://aibi.org.in/

http://aibi.org.in/

http://aibi.org.in/

http://aibi.org.in/

http://aibi.org.in/

http://aibi.org.in/

http://aibi.org.in/

https://www.amfiindia.com/







Thank you !!!!!

For further interactions:Dr. Jinesh Panchali

Arham Advisors

Navi Mumbai

Email: [email protected]

Cell: +917506351972


mailto:[email protected]





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