NPAs with sponsor banks - are my MF investments safe?

Read my article on this subject in Mid-day Gujarati, Mumbai edition today.

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The English translation is as under:

Right now when the PSU banks are burdened with so much NPAs, are the mutual funds sponsored by these banks safe?

For the last few months, the media is abuzz with the reports on Non-Performing Assets of the banks. Some reports talk about large numbers and some scare the readers without the mention of any numbers.

A mutual fund is a trust that holds various different schemes. Each mutual fund scheme is a separate portfolio of investments. The scheme invests in various securities in line with its stated investment objective. The money invested in a mutual fund scheme is not invested with the sponsor.

Let us understand how mutual funds are structured. This will help us with the above question.

A sponsor company sponsors (promotes) the mutual fund and the asset management company. The mutual fund is set up as a trust for the benefit of unit holders, who invest in various schemes launched by the fund. The asset management company’s primary function is to manage the investments of various investors that invest in the mutual fund schemes.

Now, even at the cost of repetition, it is important to highlight that the investors invest in the schemes launched by the mutual fund, whereas the asset management company only manages the funds.

The unit holders are the owners of the scheme, whereas the asset management company is the manager. How do the investors know whether the schemes are managed in their best interests?

This is where a third entity enters – the trustees, either in form of a trustee company or a board of trustees. Since the mutual fund is set up as a trust, these trustees oversee the functioning of the asset management company, to ensure that the funds are managed in the best interests of the unit holders.

The asset management company can only invest the funds in the manner specified by the offer document within the SEBI regulations.

If something happens to the asset management company, the schemes would not be impacted since the money is not invested with the company but in various securities. The trustees have the right to change the manager. Similarly, if something happens to the sponsors, the unit holders’ money invested in the mutual fund schemes is safe.

It is this three-layered structure that ensures safety of the investors’ funds in the mutual fund schemes.

Having said that, there is another point that we need to discuss here. What if the scheme has invested in companies that have turned bad? The way the loans have turned into NPAs, what if the investments made by the mutual funds turn out to be bad? That risk is directly on the investors. However, once again there is a built-in safety for the investors. First of all, the mutual fund scheme is allowed to invest only upto a certain limit in any single company or any single industrial group. This means, the risk of business failure is spread across many investments, thus reducing the impact. Secondly, mutual fund portfolios are very transparent and hence, one can see the investments made by the fund schemes on a regular basis. Almost all funds in India declare their portfolios on a monthly basis. Third, the schemes are managed by professional fund managers, whose full time job is to manage investors’ money. A professional manager is likely to be better at selection of securities than most individual part-time investors.

So go ahead and invest your money in mutual funds. Even if the sponsor bank has very high NPA levels, your investments in the mutual fund schemes are not affected by those NPAs.

- Amit Trivedi