Should one take financial advice seriously if the advisor won’t face any consequences from his wrong calls? Would fishermen catch turtles instead of fish if they also had to eat them? Nassim Nicholas Taleb raised these questions in 2018 book, Skin in the Game: Hidden Asymmetries in Life. He argued that for success in any profession, the seller needs to share in the risks of the buyer. SEBI has taken Taleb’s ideas to heart. To ensure that top officials of mutual funds don’t take out-sized risks and unleash losses on investors, it has now directed that top employees of mutual funds need to eat their own cooking.
New rules
· Key employees of asset management companies should be paid a minimum 20 per cent of their annual CTC (cost to company) after provident fund contributions and taxes, in mutual fund units in schemes in which they have a role. ‘Key employee’ here means not just the fund managers but also the mutual fund CEO, CIO, COO and many others. .
· If an employee has a role in multiple schemes, he or she should be paid units in proportion to their assets.
· If an employee or fund manager is involved with only one scheme, 50 per cent of his payout will be through units in that scheme and 50 per cent in others that he chooses, of similar or higher risk profile.
· These units will be locked in for 3 years.
· This won’t apply to employees handling ETFs, index funds, overnight funds and close end schemes.
· The compensation paid to each key employee in units should be disclosed on the mutual fund’s website.
These new rules are unlikely to transform a mediocre fund manager into a great selector of stocks or bonds, or transform him into a better navigator of market ups and downs. Therefore, factors such as the ability to beat benchmarks, track record across market cycles and downside containment matter far more than skin in the game (SITG) while choosing a fund.
To ensure that a fund manager’s interests are truly aligned with yours, he has to have a significant portion of his portfolio invested in the scheme he manages.
SEBI’s new SITG rules do not guarantee this. For a fund manager who has been in the profession for several years, 20 per cent of a single year’s net income will work out to a small component of his or her net worth.
. If they have no investments in a particular scheme to start with, the incremental investment from this rule is unlikely to be large enough to constitute significant SITG. Therefore, pay attention to the value of investments.
Is it voluntary?
In signalling preferences, voluntary actions by MF insiders count more than actions that are forced by regulations. Even before SEBI’s new rules kicked in, some AMCs had voluntary opted for SITG. Parag Parikh AMC has its promoters as well as key employees holding a ₹220 crore across its three schemes. Motilal Oswal AMC’s promoters are among the largest investors in its equity schemes while fund managers at HDFC Mutual Fund and DSP Mutual Fund feature very significant holdings by their directors and fund managers in some of their equity schemes. ICICI Prudential AMC has for a while now, been paying bonuses of its senior employees in the form of fund units.
When using SITG as an indication of where to park your money, therefore, run a check on the total quantum of employee investments in a scheme before this SEBI rule came into effect. Given that SEBI has allowed fund managers to allocate 50 per cent of their payout to funds other than their own, look out for fund managers investing in schemes that they don’t manage, as this is a strong indicator of schemes that they think highly of.
As SITG is not compulsory in index funds, ETFs and close end funds, these contributions are likely to be wholly voluntary.Watch out for trends that show insiders selling their SITG positions (which they can do after 3 years).
Don’t mirror allocations
Don’t try to copy the asset allocation patterns of MF insiders based on SITG information. Most mutual fund honchos are quite well-paid and may have a far higher risk appetite than yours. Therefore, SITG bets on risky categories such as small-cap thematic or credit risk should not be a reason for you to go whole hog on such schemes.
Two, by requiring non fund managers to spread out their SITG investments across schemes in proportion to their assets, SEBI’s rules automatically ensure large SITG investments for big schemes.
If an AMC’s largest scheme is their liquid fund or their arbitrage fund, this doesn’t mean you should fancy it too. How much of your own portfolio should be allocated between equity and debt and risky and safe scheme categories, should to be a function of your personal risk appetite and financial goals, and not anyone else’s.