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Capital markets regulator SEBI has instructed companies or AMCs which do the investment in equities and bonds for mutual fund investors that their key employees, including fund managers, should be paid a fifth of their annual compensation in the form of units of the schemes they manage. The rule kicks in from 1 July. The investments will have a three-year lock-in; the employees can’t redeem the units before that period.

The intention, it said in a circular of 28 April, is to align key employees’ interests with those of their investors. If fund managers have a stake in their schemes and are likely to be financially pinched by their judgments, they might become cautious in the investments they make and be less prone to taking reckless bets.

Fund managers have a fiduciary responsibility

Mutual fund investment is an act of trust. Fund managers have a fiduciary responsibility to the people who place money in their care to not only protect capital but also make it grow as per the stated goals. There are legal provisions to deal with acts of fraud, breaches of trust, or violations of conduct codes. But when investors suffer because of poor judgment or risky bets, it is fair that fund managers should share the pain. That seems to be SEBI’s thinking.

“It is a good move,” says Prithvi Haldea, the founder of Prime Database, a pioneering capital market service that has information on more than 75,000 equity issuances made over the past 30 years. “Fund managers would now be even more diligent about the schemes they manage.”

“It is a good way to assure the investors that fund managers are also invested alongside,” says Rohit Vajpayi, director of Starseed Investments, a Delhi-based advisory. “Managers investing in their own funds is a good signaling factor for investors,” he added comparing it to employee stock options.

Well-intentioned but impractical, says Larissa Fernand, editor of Morningstar in a comment posted on its website. Morningstar analyses and compares mutual funds as part of its financial research and advisory service to individual investors and investment professionals. Asking fund managers to be invested in their mutual fund scheme is akin to “dogfooding,” or requiring those working in a company that makes dog food to feed their pets with it, as proof of its safety and quality, Fernand wrote. She quoted the company’s director of fund research, Kaustubh Belapurkar calling it a “stewardship practice.” But she also flagged concerns.

The risk profile of the fund managers may not match that of the funds they manage. They might be young but the schemes they manage might have a higher debt component and may be meant for those with a lower risk appetite. SEBI’s definition of ‘key employees’ is expansive. It includes those reporting directly to the CEO of an AMC, those in research teams, and investor relations officers. They may not have a say in the bonds and shares that a fund invests in. Some of them might be young and drawing salaries that are not large enough to allow sequestering a fifth of their annual pay without affecting their cash flows.

Those who believe in minimal regulation don’t approve of SEBI acting as a nanny. Buyers of mutual fund units must exercise diligence. The phrase Caveat Emptor, or ‘let the buyer beware’ should apply. One of the reasons investors ask professional managers to handle their money, apart from the lack of time or expertise, is so they don’t get swayed by emotion: fear or greed. Professional managers who have their own skin in the game as the cliché goes might be influenced by those same judgment-clouding emotions.

“SEBI has lost the plot,” tweeted R. Balakrishnan, an independent consultant who has been CEO and CIO of a couple of mutual funds. “Would it not be ideal if SEBI could give model portfolios for every kind of scheme?” he sarcastically added.

Per SEBI there are 1,735 mutual fund schemes and 54 fund-of- funds schemes. Competition is supposed to keep fund managers in check. The conventional wisdom is that Investors will reward those fund houses that perform well. The fund houses in turn will hold the fund managers to high standards of performance by indexing their pay to it. This requires them to act competently and ethically. Despite this funds can underperform.

SEBI’s circular will add a layer or compliances. It might impose more costs on investors if AMCs try to retain scarce talent with compensatory pay for the income sequestered. It helps the regulator understand its limitations.