Legal protection

Suresh Krishnamurthy

THE legal framework for mutual funds is such that each fund's sponsors and trustees are forced to have their own asset management company.

This inhibits the outsourcing of fund management work. SEBI is said to be considering changing the laws to enable mutual funds to outsource the asset management function.

At the outset, this is certainly a welcome development and should benefit the poorly performing mutual funds, especially those in the public sector. Also, the move needs to be viewed in the light of several public sector mutual funds looking for restructuring options after their terrible experience in the industry. However, these public sector funds may not be willing to exit the sector altogether.

More important, the public sector mutual funds may be interested in outsourcing only the equity management function, while continuing to manage other operations on their own. In fact, the public sector funds may consider themselves experts in the debt management function.

However, any such change in the legal framework should also usher in changes that protect the interests of the trustees and sponsors. There should be laws which trustees, sponsors and investors can take recourse to when the asset management company slips up. Laws based on the Prudent Investor Rule _ which stipulates that a fund manager invest in a manner similar to the way he would invest his own funds _ are necessary.

Without a framework for such legal protection, it may not be in the interest of investors to divorce the function of asset management from the trustees. The need is felt even now, when mutual funds invest in securities that have been lead-managed by companies in the same group. Perhaps, asset management companies would argue that all such investments are backed by a reasonable basis. Still, it would be best to have a mechanism through which investors and trustees can take recourse to legal remedies.