'Ponzi schemes, black money big threat to mutual funds'

Last Updated: Thu, Dec 13, 2012 05:44 hrs

Ponzi schemes and other unregulated parallel market investment schemes are affecting the growth of the mutual fund (MF) sector, a senior fund manager said here on Wednesday.

A ponzi scheme is a fraudulent investment operation that pays returns to its investors from own money or money paid by subsequent investors, rather than from profit earned by the individual or organisation running the operation.

In the first candid admission of the elephant in the room by a sector insider and easily the most spirited attack on the malaise, Akshay Gupta, chief executive officer, Peerless Funds Management Company, said these schemes are among the major challenges facing the sector.

"People are cheated by a number of ponzi schemes in tier-II and tier-III centres. Agents are paid 20-40 per cent and people are promised 40 per cent return. I can't understand how this works," he said at a seminar on the road ahead for the sector, organised by The Associated Chambers of Commerce and Industry of India. Till now, MFs had stopped short of publicly acknowledging this issue. "At the end of the day, the amount raised has to be invested in financial instruments. I don't know which instrument gives 80 per cent returns. If you tell me, I am ready to invest all my Rs 10,000 crore in this instrument," said Gupta.

Peerless is one of the few funds to have been able to buck the trend and grow its assets under management from scratch in an unfriendly environment, where funds are caught between micro-regulation and a thicket of ponzi schemes. While expenses chargeable by MFs and the promises they can make are heavily regulated by the Securities and Exchange Board of India (Sebi), illegal schemes that stay out of the regulatory ambit follow none of these rules. MF agents, who earn much less than those of illegal schemes, are left with the burden of pitching a regulated product that comes with huge disclaimers on market risks against schemes claiming fantastic returns (40 per cent, doubling of money, etc).

While Sebi has been accumulating regulations for regulated MFs, it has not been able to rein in illegal schemes effectively. Even cases where the perpetrators have been caught red-handed are dragging on in the courts. For example, Sebi action against the Pearls Group, which raised money through realty plans, has been pending in the courts for nearly a decade. Another example, a recent one, is where Sahara India Pariwar raised money through debentures without following public issue procedures; Sebi has been trying to get refunds for investors.

Gupta said the huge parallel economy in India is another reason why penetration of MFs has been less than that in developed countries. In a presentation preceding Gupta, Mirae Asset's chief executive officer, Jisan Yoo, showed how South Korea, which is smaller than Uttar Pradesh, has an MF market twice the size of India's. Gupta said, "Of 1.3 billion people, only 1.4 million paid advance tax. That shows the extent of the parallel economy." The biggest threat, he said, came from the "housing bubble". "The price of a 1,500 sq ft house even on outskirts of Delhi would cost Rs 75 lakh." The sole aim of a person who enters his career with an annual package of Rs 5-6 lakh is to build his own house. He buys it with a loan and his entire life is spent servicing this loan, leaving nothing for any financial investments.

"There is a housing bubble in this country. It has to burst," he summarised.

The complexity of products and lack of accountability among distributors are other big challenges before the sector, he felt. He noted distributors have had their licences cancelled in America for not rebalancing the portfolio of clients as promised. In India, most retail assets are concentrated in equity, reflecting poor asset allocation.

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