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Investor Protection & Mutual Fund Regulations

Introduction

The primary objective of SEBI regulations is to protect the interests of investors, especially small retail investors who may not have the expertise to evaluate complex financial products. The regulatory framework acts as a safety net, ensuring that mutual funds operate with transparency, fairness, and integrity. This chapter explores the specific mechanisms and regulations that safeguard investor money.

1. Structural Protection: Separation of Functions

The most fundamental protection comes from the legal structure of mutual funds, which mandates a strict separation of functions to prevent conflicts of interest and fraud.

  • Trustees hold the assets: The AMC manages the investments, but the legal ownership of assets lies with the Trustees (on behalf of unit holders). This ensures that the AMC cannot misappropriate funds.
  • Custodian holds the securities: The physical securities (shares and bonds) are held by an independent Custodian, not the AMC. This prevents unauthorized usage of assets.
  • AMC takes decisions: The AMC makes investment decisions but does not have custody of the assets.
  • RTA maintains records: An independent RTA maintains investor records, preventing manipulation of unit holdings.

This system of checks and balances ensures that no single entity has complete control over the investor's money, significantly reducing the risk of fraud.

2. Prudential Investment Norms

SEBI has laid down strict investment restrictions to prevent reckless investing and excessive concentration of risk.

Exposure Limits

To enforce diversification, SEBI mandates:

  • Single Company Limit: A mutual fund scheme cannot invest more than 10% of its NAV in the equity shares or debt instruments of a single company.
  • Sector Limit: A debt scheme cannot invest more than 20% of its NAV in a single sector (e.g., Real Estate or Power).
  • Group Limit: Investments in companies belonging to the same corporate group (e.g., Adani Group or Tata Group) are capped at 20% of NAV.

Prohibition on Certain Investments

  • No Lending: A mutual fund cannot lend money or provide loans.
  • No Option Writing: Promoting unlimited risk is prohibited; funds typically cannot write (sell) options unless fully covered.
  • Restrictions on Sponsor Group: A scheme cannot invest more than 25% of its NAV in the group companies of the sponsor.

3. Mandatory Disclosures and Transparency

Sunlight is the best disinfectant. SEBI ensures protection through rigorous disclosure norms.

  • Daily NAV: The Net Asset Value must be declared by 9:00 PM every business day, ensuring investors know the exact value of their holdings.
  • Monthly Portfolio: The full portfolio usage (every single stock and bond held) must be disclosed monthly on the AMC website.
  • Half-Yearly Financials: Unaided financial results and portfolio statements are sent to all investors twice a year.
  • Expense Ratio Disclosure: Daily TER must be published on the website; any change requires prior notice to investors.
  • Risk-o-meter: Every scheme must display a risk-o-meter to clearly communicate the level of risk associated with the fund.

4. Tight Liquidity Management

Post the Franklin Templeton crisis (2020), SEBI tightened norms for debt funds to ensure they can meet redemption pressures.

  • Liquid Assets Requirement: Liquid funds must hold at least 20% of their assets in liquid cash equivalents (like T-Bills or Repo) to handle sudden redemptions.
  • Stress Testing: AMCs must conduct periodic stress tests to evaluate if the portfolio can withstand severe market conditions and redemption pressures.
  • Swing Pricing: In times of market dislocation, an exit load (Swing Pricing) can be imposed to discourage panic redemptions and protect remaining investors from value erosion.

5. Unclaimed Dividends and Redemptions

Sometimes, dividend warrants or redemption cheques are lost in transit or investors forget to update their bank details.

  • AMCs must maintain a list of such unclaimed amounts.
  • These amounts must be invested in a specific plan (usually liquid/money market) so they continue to earn returns.
  • Investors can claim these amounts at any time along with the accrued interest. SEBI mandates AMCs to provide a search facility on their websites to help investors trace unclaimed money.

Case Study: "Side Pocketing" (Segregated Portfolio)

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Summary

  • Structural Safety: Strict separation of custodial, management, and oversight functions prevents fraud.
  • Prudential Norms: Investment caps (10% single stock, 25% sector) ensure diversification and risk control.
  • Transparency: Mandatory daily NAV, monthly portfolio disclosures, and risk-o-meters keep investors informed.
  • Debt Fund Reforms: Liquidity buffers and stress testing ensure funds can honor redemptions during crises.
  • Side Pocketing: A mechanism to segregate bad assets ensures fairness during credit events.

Quiz Time! 🎯

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