Mutual Funds

Understanding how the fund industry works

PV Subramanyan | Updated on January 20, 2018 Published on March 27, 2016

A Trust structure ensures safety of our funds even if the AMC goes bust



Mutual funds are professionally managed and well-regulated. These are two solid reasons why mutual funds can be an important wealth creation tool.

Structured as a trust

As unit holders in the funds, we are the real owners of the assets but the Trust is the nominal owner. Such a structure ensures that the assets (our assets) remain safe even if the asset management company (AMC), which does the actual management of funds, goes bankrupt. Even bankruptcy is almost impossible because the AMC is not allowed to do any other business. For e.g. it cannot get into banking or life insurance business. It can only do fund management; it can run a PMS (portfolio management services) but not anything else.

Trustees

The trustees look at the holistic picture of the fund house, make sure that the registrar, auditor, distributors are all doing their job and that the complaints are well-handled. The trustees have to ensure that compliance is well taken care of, the custodian documentation is good and that there is a good internal control in place. They have to ensure that the funds do what they are supposed to do — so a liquid fund cannot buy a security maturing in 20 years, or load an income fund with equities. In case of a fraud, the trustee can be sued and he will have to pay the fine from his personal resources.

Board of Directors

The fund management is done by the Asset management company and this company has a board with independent directors as well as interested directors. The board handles the day-to-day administration of the company through a managing director. He is responsible for the compliance — to all the rules of the business. He has to ensure that there is no conflict of interest between the employees and the unit holders. He has to ensure that the vendors appointed are all compliant; the Registrar (for the administration of the schemes) is SEBI-compliant; the distribution is streamlined; the complaints are taken care of, etc.

Transparency

Mutual funds come out with an offer document for schemes which states what the funds will do, who are its trustees, auditors, directors, the potential composition of portfolio, etc. This document is vetted by the compliance officer, circulated among the board, signed by the managing director (for and on behalf of the board), approved by the trustees and accepted by the regulator.

The compliance officer has to ensure operational level accuracy and tell the Board that all the operational things are in place. Then the Board of Directors and the Trustees approve it.

Rewards

Finally, the schemes are managed by professionals who do not have an ‘ownership’ interest in the fund/scheme. The fund manager’s fee is on the Assets Under Management (AUMs) and he does not get rewarded except, of course, by a slightly higher remuneration based on the increased AUM. Thus they do not get a share of the profit.

The writer is a financial advisor.

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