For most people, mutual funds are an entry point into financial markets since they are easy to understand and a convenient way to invest. They don’t call for the same degree of oversight by investors as other asset classes might since they are professionally managed by asset management companies (AMCs).
They also come with convenient modes of investment like SIPs so you need not fret about short-term market movements. But amid all this ease and convenience, it’s easy to miss important details like where exactly does your money go when you invest in mutual funds.
Where does your money go?
Mutual funds are essentially pooled investment schemes, which means your funds have to get pooled somewhere down the line. The question is at what point does it get pooled?
In most cases, if you invest in mutual funds through distributors or brokerages, your money gets pooled with financial intermediaries at various levels before it reaches the mutual fund house. This in turn affects how soon your SIPs and lump sum investments are executed.
For the individual investor, there is a clear difference between SIPs and lump sum investments. But the usual practice among brokerages and distributors is to use an exchange-based platform, or in the case of direct AMC integrations, a payment aggregator. In both cases, funds are pooled and transferred as one large payment to the AMC which is reconciled back to individual investors.
This process is the reason you might have noticed significant delays between the time your money is debited from your bank account and the time by which you are allotted mutual fund units. A similar process is followed when you redeem your investments as well.
During this time, investors are exposed to counterparty risk, which is the risk of fraud and misuse of these funds from the company handling your funds in the interim. Additionally, it may cause a delay in investors receiving same-day Net Asset Value (NAV) as your funds may not be immediately available with the AMC.
To protect investor interest and mitigate such risks, market regulator Securities and Exchange Board of India (SEBI) has done away with this practice and mandated the direct transfer of funds from investors’ bank accounts to mutual fund houses and vice versa.
What does this mean for you?
SIP failures can occur due to various reasons such as insufficient balance in the investor’s account. Reconciliation failure can occur when financial intermediaries are unable to map the funds in a pooled account to a specific investor.
Each transaction, from the investor’s account to the broker, from the broker to the payment aggregator and finally to the mutual fund house, represents a potential point of failure. While there could be teething issues as the industry shifts to direct transfers, SEBI’s new rules greatly reduce the possibility of such transaction failures in the long run.
Similarly, the new rules will remove the delay in mutual fund unit allocation. It means investors can get units allocated at the same day NAV. This opens up the potential for mutual fund investors to capitalise on short-term market movements in addition to benefits like rupee cost averaging that SIPs provide.
Based on a study of market data over the last 15 years, the Fi Money Research team found that an investor who has set up daily SIPs in equity mutual funds can gain an incremental average annual return of up to 1.5% by upping the amount on days when the NIFTY falls meaningfully.
A mutual fund platform with innovative market-linked investment rules will be able to automate such an investment strategy, making it as simple as setting up your usual monthly SIPs.
With higher transaction success rates, same-day NAV unit allocation and reduced risks, these new regulations will greatly improve the efficiency of service, user experience and security for mutual fund investors.
Praneet Battina, Investment Team, Fi Money