SEBI skin in the game mandate: Comforting for investors, agony for AMC employees

The Securities Exchange Board of India’s directive to mutual fund companies to pay 20% of the salaries of their key employees in the form of units of schemes in which they have some role is sure to create ripples within the industry. Fund houses are likely to see this as an unwarranted intrusion in their functioning and a sort of regulatory overreach that intrudes into the freedom of their employees.

SEBI has mandated that “a minimum of 20% of the salary/perks/bonus/non-cash compensation (gross annual cost-to-company) net of income tax and any statutory contributions (provident fund and national pension scheme) of the key employees of the AMCs shall be paid in the form of units of MF schemes in which they have a role and oversight”.

In its directive, the capital market regulator has said that the objective is to “align the interests of the key employees of the asset management companies (AMCs) with the unit holders of the schemes”.

The 20% set aside for units of their own schemes would have a 3-year lock in unless the person is superannuating.

The SEBI directive would, in effect, mean that come July 1, when the circular comes into effect, many employees of fund houses will see a sudden reduction of their take home salaries. Implementing the elaborate circular would also be a nightmare for the human resources department of fund houses.

Apparently one of the reasons that prompted SEBI to come out with the circular was the audit revelation that some Franklin Templeton employees had redeemed their investment in their own funds just prior to the announcement of their closure of six debt schemes. Fund houses can argue that the entire industry should not be held guilty or be punished for one bad apple, or maybe a few of them.

What does it entail for investors?

However, that is one side of the story. The other question is what does the SEBI circular hold for investors? Will the move automatically ensure better fund management? The answer appears to be in the negative. A fund manager’s fund management skills are unlikely to change with the amount of ‘skin in the game’. In fact, being heavily invested in funds managed by self might make the fund manager more cautious, thereby inhibiting risk-taking ability and consequently, long term returns. Also, external factors that impact the market would continue to play their role, irrespective of the amount of units held by the fund manager.

Investors are supposed to invest their money in mutual funds after assessing their own risk profiles, doing a thorough study of the performance of the fund house and the schemes and an assessment of the ability of the fund manager to deliver. It would be extremely naïve to think that they would be able to study the personal investment of a fund manager in their own schemes, especially if the 20 per cent so deducted is split between multiple schemes, all showing different performances against their respective benchmarks. As per the SEBI circular, CXO of large fund houses might have to split the 20% amount in multiple schemes, running into many scores.

SEBI move may trigger high attrition

Skin in the game – meaning fund managers and key employees investing in their own schemes – could be a comforting element for many investors, provided it is done voluntarily. Investors would treat it as a sign that fund manager’s belief in the future performance of the scheme. However, having to do so mandatorily would somewhat negate this aspect.

The directive can also lead to unhappiness and exodus from the mutual fund industry to similar jobs in other industries, including pension funds and life insurance companies. If such exodus happens, it could impact take away the better among the lot, thereby impacting fund performance and investors negatively.

SEBI’s directive would only indicate that the fund manager will also sink along with investors if their schemes underperform. It might not assure better performance. It would have been better to leave it up to fund houses to encourage their fund managers and other employees to invest in their own schemes with regular disclosures along with a monthly factsheet to disclose if the key employees are committing more money or selling out.

Let investors and investment advisors decide whether or not they want to go to a shop where the key employees have skin in the game.