AMC or Mutual Fund house is the company responsible to manage the assets of the Mutual Funds and takes care of its day to day operation. The AMC consists of the Chief Investment Officer, the fund managers and analysts, who are together responsible for managing the various schemes launched. ICICI Prudential Asset Management Company Ltd is the AMC of ICICI Prudential Mutual Fund.
1. Sponsor (Promoter of a Mutual Fund)
Every project needs a promoter, a prime mover who has overall responsibility for the project. The promoter of a mutual fund is referred to as “Spnsor” As per the regulations, a sponsor means, “any person who, acting alone or in combination with another body corporate, establishes a mutual fund.”
A sponsor has to meet the following qualifications prescribed by SEBI:
(i) Sponsor should have a sound track record and general reputation of fairness and integrity in all business transactions.
Sound track record means:
> Carrying on business in financial services for a period of not less than five years.
> Having a profit, after providing for depreciation, interest and tax, in three out of the immediately preceding five years, including in the latest year.
> Having a positive net worth in all the immediately preceding five years. (Net worth = paid up capital plus free reserves, minus miscellaneous expenditure not written off, minus deferred revenue expenditure, minus intangible assets, minus accumulated losses).
> In the immediately preceding year, having a net worth that is more than the capital contribution of the sponsor in the AMC.
(ii) The sponsor has to contribute at least 40 % to the net worth of the AMC. Further, any person who holds 40 % or more of the net worth of an AMC is deemed to be a sponsor and should, therefore, meet all the qualifications prescribed for a sponsor.
(iii) Sponsor should be a fit and proper person.
(iv) Sponsor, or any of its directors, or the principal officer to be employed by the mutual fund should not be guilty of fraud or convicted of an offence involving moral turpitude or found guilty of any economic offence.
While meeting the prescribed qualifications makes a person eligible to promote a mutual fund, the venture cannot be promoted unless SEBI permits it.
(v) There are certain eligibility criteria to become a Sponsor, as prescribed under:
a. The Sponsor must have profit in 3 of the last 5 years including immediately preceding year.
b. The Sponsor must have a minimum of 5 years of experience in financial services.
c. The net worth of the Sponsor must be positive for all the preceding five years.
d. Out of the total net worth of the AMC, 40% must be participated by the Sponsor.
As seen above, the position of a Sponsor is crucial and they should have high credibility. Strict norms show that the sponsor must have enough liquidity and faithfulness to return the money of an innocent investor, in case of a financial meltdown.
2. Investors in Mutual Fund
Every investor, given her financial position and personal disposition, has a certain inclination to take risk (risk appetite). The hypothesis is that by taking an incremental risk (of losing capital, wholly or partly), it would be possible for the investor to earn an incremental return.
But assuming risk without regularly monitoring it is foolhardy. Therefore, it would be prudent for investors who take a risk to be able to manage this risk.
A mutual fund is the solution for investors who lack the time, the inclination or the skills to actively manage their investment risk in individual securities. They can delegate this role to the mutual fund, while retaining the right and the obligation to monitor their investments in the scheme (which, in turn, invests in individual securities).
In the absence of a mutual fund option, the moneys of such “passive” investors would lie either in bank deposits or other “safe” investment options, thus depriving them of the possibility of earning a better return.
Investing through a mutual fund would make economic sense for an investor if her investment, over the medium to long term, fetches a return (net of all costs, expenses and taxes) that is higher than what she would otherwise have earned by investing directly, or parking the funds in the bank.
As Bogle succinctly puts it, “Because the goal of investing is to accumulate real wealth — an enhanced ability to pay for goods and services — the ultimate focus of the long-term investor must be on real, not nominal, returns.” 1(Nominal Returns minus Inflation = Real Returns).
3. Trust and Trustees
Trustees are the people within a mutual fund organization who are responsible for ensuring that investors’ interests in a scheme are properly taken care of.
As the name suggests, they have a very important role in maintaining the trust of the investors and to oversee the growth of the fund. SEBI mandates the trustees to provide a report on the fund and the functioning of the AMC on a half-yearly basis. Trustees can be created either in the form of Board of Trustees or a Trust Company. The Trustees supervise the entire functioning of the AMC and regulate the operations of the mutual fund schemes. The SEBI has tightened the rule of transparency so as to avoid any conflict of interest between the Sponsor and the AMC. Without the permission and approval of the Trust, an AMC cannot float a new mutual fund scheme. It is important for the Trustees to act independently and take appropriate measures to safeguard the hard earned money of the investors. The Trustees are also required to be registered under SEBI, and SEBI further regulates their registration by either suspending or revoking the registration if found breaching any conditions.
In return for their services, they are paid trustee fees, which are normally charged to the scheme.
Their roles and responsibilities are discussed in detail as follows:
(i) The Trustee shall enter into an investment management agreement with the AMC
(ii) They shall be accountable for, and be custodian of , the funds and property of the respective schemes and shall hold the same in trust for the benefit of the unit holders.
(iii) Every half-yearly, the trustee shall furnish to SEBI a Report on the activities of the Mutual Fund.
(iv) Trustees shall ensure that all activities of the AMC are in accordance with the provisions of the SEBI regulations.
(v) If they have reason to believe that the conduct of business of the mutual fund is not in accordance with the regulations or the offer document of the scheme, they shall take appropriate remedial steps and inform SEBI immediately.
(vi) Each trustee shall file the details of her transactions in securities with the mutual fund on a quarterly basis.
(vii) They shall meet at least once every two calendar months, and at least six such meetings shall be held every year.
(viii) They shall call for details of transactions in securities by the key personnel of the AMC.
(ix) They shall review quarterly, all transactions between the mutual fund, AMC and its associates.
(x) They shall review quarterly, the net worth of the AMC and ensure that any shortfall is made up.
(xi) They shall periodically review the investor complaints received and their redressal by the AMC.
(xii) They shall abide by the prescribed code of conduct.
4. Trusteeship of Mutual Funds
(1) Trust Deed
A mutual fund has to be constituted in the form of a trust, created through a trust deed.
The trust deed:
> Has to contain certain clauses prescribed by SEBI;
> Can not contain any clause that:
– limits or extinguishes the obligations and liabilities of the trust with respect to the mutual fund or its investors; and
– indemnifies the trustees or the AMC for loss or damage caused to the unit holders on account of negligence or acts of commission or omission;
> Has to be duly registered under the provisions of the Indian Registration Act, 1908; and
> Has to be executed by the sponsor in favour of the trustees named in the deed.
Indian companies are governed by the Companies Act, 2013. Limited Liability Partnerships (LLPs) in India are governed by the LLP Act, 2008. Other Indian partnership firms are governed by the Indian Partnerships Act, 1932. Similarly, mutual fund trusts in India are governed by Indian Trusts Act, 1882.
Companies are real entities that are eligible to contract in their own name. Trusts, on the other hand, are notional entities that are not eligible to contract in their own name. Trusts, therefore, need to enter into contracts in the name of the trustees.
The Indian Trusts Act, 1881 gives two options for the constitution of trustees:
> An individual can be appointed as trustee. When more than one trustee is appointed, they would together constitute the Board of Trustees.
> A company can be appointed as trustee. Such a trustee company, like any company under the Companies Act, 2013, would have a Board of Directors.
Every trust has beneficiaries, namely the persons for whose benefit the trust has been created — and trustees, namely the persons who are responsible for protecting the interest of beneficiaries.
When a trust is created for mutual fund operations, the beneficiaries are the investors who invest in the various schemes promoted by the mutual fund.
(3) Disqualifications for Trustees
Given the critical role of trustees, the regulations provide stringent disqualifications. A person cannot be appointed trustee unless she:
> is a person of ability, integrity and standing;
> has not been found guilty of moral turpitude; and
> has not been convicted for any economic offence or violation of any securities laws.
A person who does not suffer from these disqualifications is eligible to become a trustee in a mutual fund. But she can be appointed as a trustee only after the prior approval of SEBI.
In order to strengthen the trusteeship and avoid potential conflicts of interest, it is provided that:
> Any mutual fund will have a minimum of four trustees.
> Two-thirds of the trustees need to be independent trustees, namely persons, who are not associates of the sponsors, or associated with them in any manner whatsoever.
> If consequent to an independent trustee vacating office, the number of independent trustees falls below the prescribed minimum, another independent trustee has to be appointed to fill the gap within three months.
> Relatives (as defined in the Companies Act) of the sponsor, directors of the sponsor company, or relatives of associate directors of the AMCs and trustee companies are considered as “associate”.
> Similarly, nominees of companies who are stakeholders in the sponsor company or AMC are considered to be “associate”.
> Persons providing any type of professional service to the mutual fund, asset management company, trustee company and the sponsors are considered as associate directors.
> Also, persons having any material pecuniary relationship with these entities, which in the judgment of the trustees may affect independence of directors, are treated as associate directors.
> An asset management company, or any of its officers or employees, are not eligible to act as trustee of any mutual fund.
> No person who has been appointed as trustee of a mutual fund can be appointed as a trustee of any other mutual fund unless:
– the person is an independent trustee; and
– the mutual fund where she is already a trustee gives prior approval for the proposed appointment in the other mutual fund.
(If a company is appointed as a trustee, then its directors can act as trustees of any other trust provided that the object of the trust is not in conflict with the object of the mutual fund).
> A person who is an “associate” in accordance with definition in the Regulations cannot be appointed as independent director even after she ceases to be an “associate” unless a cooling off period of three years has elapsed from the date of her disassociation.
> The quorum for any meeting of the trustees shall be deemed not to have been reached, unless at least one independent trustee / director is present.
> The auditor for the mutual fund has to be different from the auditor of the AMC.
(5) Obligations of Trustees
Some key obligations of trustees are as follows:
> The trustees shall enter into an investment management agreement with the AMC.
> Before the launch of any scheme, they shall ensure that the AMC has:
– Systems in place for its back office, dealing room and accounting;
– Appointed all key personnel including fund managers;
– Appointed a compliance officer to comply with regulatory requirements and to redress investor grievances;
> Appointed auditors and made suitable arrangements to handle the function of registrars;
> Prepared a compliance manual and designed internal control mechanisms including internal audit; and
> Specified norms for empanelment of brokers and marketing agents.
> They shall be accountable for, and be custodian of, the funds and property of the respective schemes and shall hold the same in trust for the benefit of the unit holders.
> Trustees shall ensure that all activities of the AMC are in accordance with the provisions of the SEBI regulations.
> If they have reason to believe that the conduct of business of the mutual fund is not in accordance with the regulations or the offer document of the scheme, they shall take appropriate remedial steps and inform SEBI immediately.
> Each trustee shall file the details of her transactions in securities with the mutual fund on a quarterly basis.
> They shall meet at least once every two calendar months, and at least six such meetings shall be held every year.
> The trustees shall obtain the consent of the unit holders:
– Whenever SEBI asks for it;
– Whenever three-fourths of the unit holders of any scheme ask for it;
– When the majority of the trustees decide to wind up or prematurely redeem the units; and
– When there is a change in the fundamental attributes of any scheme or the trust or fees and expenses payable or any other change that would modify the scheme or affect the interest of the unit holders is proposed.
> They shall call for details of transactions in securities by the key personnel of the AMC.
> They shall review quarterly, all transactions between the mutual fund, AMC and its associates.
> They shall review quarterly, the net worth of the AMC and ensure that any shortfall is made up.
> They shall periodically review the investor complaints received and their redressal by the AMC.
> They shall abide by the prescribed code of conduct.
> While filing a new scheme offer document, the trustees need to confirm that the new scheme is a new product of the mutual fund, and not a minor modification of an existing scheme, fund or product. This is however not applicable to fixed maturity plans and closed-end schemes.
> Every half-year, the trustees shall furnish to SEBI:
– A report on the activities of the mutual fund;
– A certificate that they have satisfied themselves that there have been no instances of self-dealing (e.g., selling own securities to the fund or buying securities from the fund) or front running (e.g., buying or selling shares for self, prior to executing similar transaction on behalf of the fund) by any of the trustees, directors and key personnel of the AMC; and
– A certificate that the AMC has been managing the schemes independent of any other activities.
> The independent trustees shall give their comments on the report received from the AMC regarding investments by the mutual fund in the securities of group companies of the sponsor.
> The trustees shall be discerning in the appointment of directors on the board of the AMC.
(6) Rights of Trustees
> The trustees have the right to obtain from the AMC, such information as they consider necessary to fulfil their obligations.
> A majority of the trustees have the right to terminate the appointment of an AMC. Any change in the appointment of the AMC is, however, subject to prior approval of SEBI and the unit holders.
> The trustees shall not be held liable for acts done in good faith if they have exercised adequate due diligence honestly.
5. Asset Management Company (AMC)
AMCs manage the investment portfolios of schemes and handle various other routine activities incidental to the mutual fund business. An AMC’s income comes from the management fees it charges the schemes it manages. The management fee is calculated as a percentage of net assets managed. Some countries provide for performance based management fees as well.
In order to earn the management fee, an AMC has naturally to employ people and bear all the establishment costs that are related to its activity, such as for premises, furniture, computers and other assets, software development, communication costs, etc. These are to be met out of the management fee earned.
Expenses such as on distributor commission, marketing, etc. can be directly borne by the mutual fund scheme. However, in some cases competition in the marketplace could force an AMC to bear some of these costs, which would otherwise have been borne by investors in the schemes.
So long as the income earned through management fees more than covers its expenses, an AMC is economically viable.
Given the nature of its activity, a certain minimum establishment and infrastructure is necessary for an AMC’s functioning. Since costs cannot be reduced below a base level, every AMC needs to have a reasonable corpus of assets under management (AUM), below which it may not be viable.
The break-even level of AUM is a function of cost structure of the AMC and distribution of assets between its different types of schemes. It may be noted that debt schemes and index schemes generally yield a lower management fee. As a thumb-rule, in the Indian context it is difficult for an AMC to break-even if its AUM is below 10,000 crore.
(1) Appointment and Termination
It is obligatory for every mutual fund to have an AMC to manage the mutual fund and operate its schemes. The actual appointment could be made either by the sponsor or, if so authorized by the trust deed, the trustees.
The appointment can be terminated by a majority of the trustees or by 75 % of the unit holders. Any change in the appointment of the AMC is, however, subject to prior approval of SEBI and the unit holders.
(2) Business Activities for AMC
An AMC shall not:
> Act as a trustee of any mutual fund.
> Undertake any other business activities except portfolio management services and advisory services to offshore funds, pension funds, provident funds, venture capital funds, management of insurance funds, financial consultancy and exchange of research on commercial basis (“other activities”). This would again be subject to:
– the other activities not conflicting with the activities of the mutual fund;
– SEBI being satisfied that the key personnel, systems, back office, bank and securities accounts of the other activities are segregated from the mutual fund activities; and
– the AMC meeting the capital adequacy requirements, if any, of each such activity.
> Invest in any of its schemes unless full disclosure of the intention to invest has been made in the offer documents (The AMC cannot charge management fee on its investment in the scheme).
(3) Qualifications for AMC
AMCs need to fulfil the following conditions:
> Existing AMCs should have a sound track record (net worth and profitability), and general reputation for fairness and integrity in transactions;
> The AMC has to be a fit and proper person;
> Key personnel of the AMC should not have been found guilty of moral turpitude or convicted of economic offence or violation of any securities laws nor should they have worked for any AMC or mutual fund or any intermediary during the period when its registration has been suspended or cancelled at any time by SEBI; and
> The AMC should have a net worth of not less than 50 crore if it wants to manage mutual fund schemes. The requirement is Rs. 10 crore if the AMC wants to only manage infrastructure debt funds.
(4) Corporate Governance
> The directors of the AMC need to be persons having adequate professional experience in finance and financial services related fields and shall not have been found guilty of moral turpitude or convicted of economic offence or violation of any securities laws.
> At least 50 % of the directors on the AMC’s board shall not be associate of, or be associated in any manner with, the sponsor or any of its subsidiaries or the trustees (these are referred to as “independent directors”; other directors are “associate directors”).
> If, consequent to an independent director vacating office, the number of independent directors falls below the prescribed minimum, another independent director has to be appointed to fill the gap within three months.
> The provisions regarding “associate”, mentioned in the section on trustees, are also applicable for associate directors in AMCs.
> The chairman of the AMC shall not be a trustee of any mutual fund.
> No appointment of a director of an AMC shall be made without prior approval of the trustees.
> No person who has been appointed as director of an AMC can be appointed as a director of any other AMC unless:
– the person is an independent director, and
– the AMC where she is already a director approves the proposed appointment in the other AMC.
> Broking limits:
– An AMC cannot, through any broker associated with the sponsor (related broker), purchase or sell securities worth 5% or more of the aggregate purchases and sales of securities made by the mutual fund in all its schemes (the 5% limit is applicable for a block of any three months and excludes the sale and distribution of units issued by the mutual fund).
– An AMC shall not through any broker (other than a related broker) purchase or sell securities worth 5% or more of the aggregate purchases and sales of securities made by the mutual fund in all its schemes unless it justifies the same in writing and reports all such investments to the trustees on a quarterly basis (the 5% limit is applicable for a block of three months).
> An AMC shall not utilize the services of the sponsor or any of its associates, employees or their relatives for any securities transaction and distribution and sale of securities unless it is disclosed to the unit holders and the brokerage or commission paid is disclosed in the half-yearly and annual accounts of the mutual fund.
> If the AMC enters into any securities transactions with any of its associates, a report to that effect shall be sent to the trustees at its next meeting.
> In case any company has invested more than 5 % of the net asset value of a scheme, the investment by that scheme or by another scheme of the same mutual fund in that company or its subsidiaries has to be brought to the notice of the trustees by the AMC and also disclosed in the half-yearly and annual accounts along with justification for such investment. The disclosure is to be made if the latter investment has been made within one year of the date of the former investment calculated on either side.
For instance, if Company A holds more than 5% of the units of a scheme floated by Mutual Fund XYZ, then investments by all schemes of Mutual Fund XYZ in Company A or its associates are to be disclosed. Such disclosure is to be made if the subsequent investment has been made within 1 year of the first investment.
> The AMC has to give a quarterly report to the trustees giving details and adequate justification about the purchase and sale of the securities of the group companies of the sponsor or the AMC.
> Every quarter, the AMC has to give the trustees, a statement of securities transactions of the directors of the AMC. For this purpose, security transactions below 100,000 in value may be ignored.
> The mutual fund shall disclose, at the time of declaring half-yearly and yearly results:
– Underwriting obligations undertaken by the schemes of the mutual fund with respect to issues of securities by associate companies;
– Subscription by schemes in issues lead managed by associate companies; and
– Subscription to any issue of equity or debt on private placement basis where the sponsor or its associate companies have acted as arranger or manager.
(5). Maintenance of Investor Records
The AMC can either handle the RTA work in-house, or it can appoint a SEBI approved RTA.
If handled in-house, the AMC can charge the schemes competitive market rates for the service. If the AMC proposes to charge higher than the competitive market rates, then prior approval of the trustees is to be obtained and reasons for such higher rates has to be disclosed in the annual accounts.
(6) Other Obligations of an AMC
> The AMC will float schemes for the mutual fund only after the trustees approve them.
> It shall issue or publish offer document of a scheme, key information memorandum, abridged half-yearly results and annual results only after prior written approval of the trustees.
> The AMC shall take all reasonable steps and exercise due diligence to ensure that the investment of funds pertaining to any scheme is not contrary to the provisions of the regulations and the trust deed.
> The sponsor or AMC need to invest at least 1 % of the amount raised in NFOs of open-end schemes. The investment, subject to a cap of Rs. 50 Iakh, is to be made in the growth option of the scheme, and cannot be redeemed until the scheme is wound up.
> It shall not carry out its operations including trading desk, unit holder servicing and investment operations outside the territory of India.
> It shall exercise due diligence and care in all its investment decisions as would be exercised by other persons engaged in the same business.
> The AMC shall maintain proper books of accounts, records and documents for each scheme. It shall maintain and preserve these for a period of eight years.
> The AMC shall be responsible for the acts of commission or omission of its employees and its other service providers.
> The AMC shall submit to the trustees, quarterly reports on its activities and the compliance with the regulations.
> The AMC shall file with the trustees, details of transactions in securities by key personnel of the AMC.
> The AMC shall appoint RTA who are registered with SEBI, unless the activity is to be handled in-house.
> Any change in the controlling interest of the AMC shall be only with the prior approval of the trustees, SEBI and the unit holders.
> The AMC shall furnish such information and documents to the trustees as and when required by them.
Distributors earn a commission for bringing investors into the schemes of a mutual fund. This commission is an expense for the scheme, although there are occasions when an AMC may choose to bear the cost, wholly or partly.
Depending on the financial and physical resources at their disposal, the distributors could be:
- Tier 1 distributors who have their own or franchised network reaching out to investors all across the country; or
- Tier 2 distributors who are generally regional players with some reach within their region; or
- Tier 3 distributors who are small and marginal players with limited reach.
7. Registrars & Transfer Agents (RTA)
An investor’s holding in mutual fund schemes is typically recorded by the scheme’s Registrar and Transfer Agent (RTA). Some AMCs prefer to handle this role in-house, i.e. on their own instead of appointing an RTA. The registrar or the AMC as the case may be, maintains an account of the investor’s investments in and disinvestments (redemptions) from the schemes and handles corporate actions such as dividend payments.
RTAs are an important link between fund managers and investors. They cater to the fund managers by updating them with the investor details and to investors by delivering the benefits of the fund to them. RTAs are SEBI registered entities who process the applications of mutual funds, help with investor KYC, manage and deliver periodical statements of investments, update records of investors and process investor requests. Link-in time, Karvy etc. are some of the famous RTAs in India and they provide the requisite operational support to the AMC in mutual fund activities.
8. Custody of Investments
The mutual fund shall appoint a custodian to carry out the custodial services for the schemes of the fund and inform SEBI about the appointment within 15 days.
The mutual fund shall enter into a custodian agreement with the custodian. The agreement, the service contract, terms and appointment of the custodian shall be after prior approval of the trustees.
If the sponsor or its associates hold 50% or more of the voting rights of the share capital of the custodian, or where 50% or more of the directors of the custodian represent the interest of the sponsor or its associates, then such custodian will not be appointed for a mutual fund constituted by the same sponsor or any of its associate or subsidiary company. This limitation is not applicable if:
– The sponsor has a net worth of at least 20,000 crore at all times;
– 50% or more of the directors of the custodian are those who do not represent the interests of the sponsor or its associates;
– The custodian and AMC are not subsidiaries of each other;
– No person is a director of both custodian and AMC; and
– The custodian and AMC give an undertaking to operate independent of each other.
9. Regulator (SEBI):
The Securities and Exchange Board of India (SEBI) is the primary regulator of mutual funds in India. SEBI’s Regulations called the SEBI (Mutual Funds) Regulations, 1996, along with amendments made from time to time, govern the setting up a mutual fund and its structure, launching a scheme, creating and managing the portfolio, investor protection, investor services and roles and responsibilities of the constituents.
The Association of Mutual Funds in India (AMFI) is the industry body that oversees the functioning of the industry and recommends best practices to be followed by the industry members. It also represents the industry’s requirements to the regulator, government and other stakeholders.
(10). Other Participants
Some other participants in the structure of mutual funds are
> auditors, and
The brokers are responsible to attract investors and help to disseminate the fund. The brokers help investors in sell, purchase of units and provide with their valuable advice. Brokers also study the market trend and predict the future movement of the market.
Unlike brokers, auditors are an independent internal watchdog, who audit the financials of the AMC, Trustee, and Sponsor and provide their report.
Bankers are also an important participant, who act as collecting agents on behalf of the fund managers.
These are the participants who play a key role in the management of mutual funds. Each participant has their individual role to play. However, their functions are interlinked with each other. Mutual fund regulations are the bible by which all the participants are bound together, to perform their functions more diligently and without prejudice to the interest of the investors.