Truth in labelling

Suresh Krishnamurthy

MUTUAL funds across the globe function on similar lines, and the Indian watchdog can learn more than a thing or two from the Securities Exchange Commission of US.

The SEC has now enforced a new rule which stipulates that mutual fund names reflect the type of investments the fund makes. The Commission has said the new rule is an attempt to achieve truth in labelling and reduce confusion for investors who want to choose a product based on investment needs.

In India, this type problem has taken a turn for the worse with the launch of sectoral funds. Many sectoral funds, not only those launched by the UTI, have invested in stocks which do not form part of a particular sector. These investments are sought to be justified on two counts: One, the offer document allows such investments. Two, these funds are open-ended and, therefore, an investor not comfortable with the investment strategy can exit from the fund.

Both these arguments do not appear tenable. First, even if the offer document allows such investments, funds had held out that they would invest in a particular sector when the initial public offer was made and that is what an investor would have expected from them. The other argument -- that they are open-ended -- is also not completely applicable.

By the time the investor learns the portfolio of the fund, considerable time would have elapsed. The damage may already have taken place. Of course, it may also have turned out for the better. Yet, that is not a chance an investor would want to take time and time again in the future. And it is an unhealthy precedent for the mutual fund industry as a whole.

Any change in the investment focus of a scheme has to be notified to unitholders considerably in advance. Given the open-ended nature of the schemes, such an advance notification would cover most of the investor-issues related to a change in investment focus. Till such advance notification is made, the fund's name would have to reflect the type of investments they make.