SEBI to introduce 'seed capital', mutual fund houses must invest at least Rs 50 lakh in each of their schemes

In the software products industry, there is a concept called 'dogfooding', also known as 'eating your own dog food'. The term, which is said to have originated in Microsoft during the 1980s, refers to a company using its own products and services to demonstrate its quality. If a company's employees use its own products, then it's likely that they'll be of a reasonable quality. You can google dogfooding to learn more about it, but it's a concept that SEBI has now forced India's mutual funds to become familiar with.

In a board meeting last week, the markets regulator has decided that asset management companies (AMCs) must invest a minimum amount in their own mutual funds. Once this decision is implemented, at least 1 per cent of the total investment in each fund must come from the AMC itself, subject to a maximum of Rs 50 lakh. SEBI's press release says “The concept of seed capital to be introduced i.e. 1% of the amount raised (subject to a maximum of Rs.50 lacs) to be invested by AMCs in all the open ended schemes during its lifetime”. This has several implications. Most obviously, it means that the AMC directly has some skin in the game in its own funds. A poorly performing fund will not only means loss to the investors but also a direct monetary loss to the AMC itself.

For equity funds, the situation becomes quite interesting. That's because unlike other investors, the AMC is a committed investor and can't run away when the equity markets are expected to do badly. In a particularly bad period, an AMC could lose a significant amount of money. For example, had this rule been in place during the 2008-2009 market crash, some AMCs would have seen a good proportion of their capital being wiped out. An AMC which is managing substantial equity assets will now have an additional reason to be apprehensive of the way the markets move.

The situation is made even more complicated by the SEBI board's simultaneous decision to impose a Rs 50 crore 'capital adequacy' limit on asset management companies. While the desirability of such a rule is a topic for a separate discussion, maintaining it may require AMCs to bring in additional funds during times that the equity markets are doing poorly. Of course, all these decisions have just been cleared by the SEBI board yet and detailed regulations about the implementation are yet to come.

How AMCs will handle such situations remains to be seen, but in principle it's a good thing for investment managers to have some skin in the game. AMC promoters and boards will likely be a lot more committed to ensuring good investment management if they are also investors. Interestingly, there are fund managers who already do this.

It isn't mandatory to reveal investments in one's own fund so no comprehensive list exists. However, a few weeks back, Franklin Templeton's retiring CIO KN Sivasubramanian told Value Research that all his personal savings were invested in the AMC's own mutual funds. In the relatively small AMC PPFAS, about 8 per cent of the assets belong to the management and employees. I'm sure there are others too. In fact it's possible that lots of fund managers invest in their own funds. It's also likely that many AMCs keep their own spare cash in their own fixed income funds. However, Indian businesses rarely put any money in equity funds and it will be a novel experience for AMCs to have substantial exposure to the equity markets.

This seed capital will give AMCs a taste of what their investors feel. However, one thing is clear--the regulatory environment for Indian mutual funds and investors remains in flux.

The original article could be seen here.