India:New Route for Investing in Funds

For the last month or so, investors have had a completely new way of being able to invest in funds. Buying and selling of funds can now be done through stock brokers using the BSE and the NSE's trading system. It's important to understand that contrary to what some reports have said, this is not a way of 'trading' funds. The buying and selling does not happen between investors, which is what trading is. Instead, this is simply an alternative way of routing the same transaction that you would conventionally have done by filling up a form and handing it, along with a cheque, to a mutual fund distributor or at fund companies' office. The money is routed to the fund company and you are allotted fund units. The reverse happens when you redeem your units through a stock broker.

The new system is an additional, alternative way of investing in funds-the old system is very much in place and will remain so. The stock exchange route offers a different set of advantages and disadvantages for investors and investor need to figure out whether these make sense in their individual cases. Under this system, investors need to have an account with a stock depository, just as they would for stock-trading. At the time of opening a depositary account, their identity would be verified under the Know Your Customer (KYC) system. The advantage to investors would be that they would have a single point for dealing with all their stock and fund investments and would get a single statement of their holdings. For those investors who deal through an online brokerage, it would offer a very high degree of convenience.

Another class of investors for whom this system would make sense would be those who are living in smaller centers where mutual funds do not have offices or representatives. The stock exchange network is much wider than the fund network and incorporates not just an order-routing mechanism but also a funds-routing one.
However, investors need to be aware of what the new system is not. It is, by and large, not a good way for investors to be receiving fund investment advice. The culture of stock investing in India is one that is likely to be lethal to sensible mutual fund investing. The world of a stockbroker is one in which most clients hold investments for a few days and 'long-term' is perhaps a month or two.

Here's an example of what I mean. Even before the new system was up and running a friend of mine got a call from his broker's office. The salesman enthusiastically described the methodology that they will follow for giving mutual fund investments. They would analyse mutual funds' declared portfolios to see which stocks are likely to go up and then they will ask clients to take 'tactical positions' (the broker's words) in the funds where they like the portfolio. This is a completely counter-productive way of investing in funds but one which, I guess, would come naturally to someone whose primary skill is supposed to be stock selection. Effectively, this broker has figured out that basically, funds are a new type of trading instrument where he'll get about 0.5 per cent from the AMC rather than the pittance he gets as brokerage currently.

Taking mutual fund advice from a stock broker is a little bit like ordering milk in a bar. You may want the healthy option, but when the establishment is used to serving only the heady and intoxicating stuff, then that's what they'll try and serve to you. Brokers are a convenience for those who don't have access to mutual fund advisors, but they are unlikely to be suitable advisors.

This new system was not a fund industry or a stock exchange initiative. It was pushed by the market regulator SEBI, apparently with two motives. The first was to create a way of investing in mutual funds that should have lower costs than the traditional system. The second was to increase the geographical spread of fund availability. Apparently, one of the triggers for this action was the inability or the unwillingness of the mutual fund industry to create a joint electronic platform for fund transactions. Such a platform has been talked about for a long time but nothing concrete seems to have happened.

For investors, the bottom-line is that the new route for investing is little more than an proicedural convenience. The core of fund investing is about choosing a good fund and investing in it long-term in a steady fashion. It actually matters very little whether your investment was done by punching keys on a computer terminal or whether it was done by filling in a paper form with a pen.

by Dhirendra Kumar