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Mutual Funds - Structure & working of AMC's
Asset Management Company (AMC)
The role of an Asset management companies is to act as the investment manager of the trust. They are the ones who manage money of investors. An AMC takes decisions, compensates investors through dividends, maintains proper accounting & information for pricing of units, calculates the NAV, & provides information on listed schemes. It also exercises due diligence on investments & submits quarterly reports to the trustees. AMCs have been set up in various countries internationally as an answer to the global problem of bad loans.
Bad loans are essentially of two types: bad loans generated out of the usual banking operations or bad lending, and bad loans which emanate out of a systematic banking crisis.
It is in the latter case that banking regulators or governments try to bail out the banking system of a systematic accumulation of bad loans which acts as a drag on their liquidity, balance sheets and generally the health of banking. So, the idea of AMCs or ARCs is not to bail out banks, but to bail out the banking system itself.
The asset management industry is large, complex and fragmented. With assets in the range of tens of trillions of dollars, the industry is noted for the wide scope and depth of its investments, ranging from equities, bonds, money market and currencies, to their equivalent derivatives thereof. This had led to a perception that the industry has immense potential to affect/disrupt almost any economy in the world with its activities alone. By and large, however, the industry has remained a background player, generally taking a passive role as a minor share or bond holder on most investments in almost all bourses around the world. This is not surprising when we understand the business rationale of the industry, as we know it, is primarily that of generating fee revenues for which any market disruption, whether caused by others or themselves, would be counter-productive. But the industry is comprised of more than just fee generators. It also has investment buyers or asset owners, distributors, product architects and gatekeepers. Some of these players may have objectives different from those of the asset managers (e.g., short - term risk aversion may prevent accumulation of high-return investments), and such difference may contribute, directly or indirectly, to market disruptive behavior on the part of the industry.
It is useful to begin by identifying the various components of the industry and the complex value chain of marketing, consultation and organizational hierarchy which links the ultimate individual investor to the assets invested. The normal chain of players and events involved in a decision by an asset owner to invest and an asset manager / advisor to provide investment advisory services.
Types of AMCs in Indian Context:-
The following are the various types of AMCs we have in India:
AMCs owned by banks.
AMCs owned by financial institutions.
AMCs owned by Indian private sector companies.
AMCs owned by foreign institutional investors.
AMCs owned by Indian & foreign sponsors.
Major Asset Management Company
TATA ASSET MANAGEMENT CO. LTD.
Tata Mutual Fund (TMF) is a Trust under the Indian Trust Act, 1882. The sponsors for Tata Mutual Fund are Tata Sons Ltd., and Tata Investment Corporation Ltd. The investment manager is Tata Asset Management Limited and its Tata Trustee Company Pvt. Limited. Tata Asset Management Limited's is one of the fastest in the country with more than Rs. 7,703 crores (as on April 30, 2005) of AUM.
RELIANCE ASSET MANAGEMENT CO. LTD.
Reliance Mutual Fund (RMF) was established as trust under Indian Trusts Act, 1882. The sponsor of RMF is Reliance Capital Limited and Reliance Capital Trustee Co. Limited is the Trustee. It was registered on June 30, 1995 as Reliance Capital Mutual Fund which was changed on March 11, 2004. Reliance Mutual Fund was formed for launching of various schemes under which units are issued to the Public with a view to contribute to the capital market and to provide investors the opportunities to make investments in diversified securities.
STANDARD CHARTERED MANAGEMENT CO. LTD.
Standard Chartered Mutual Fund was set up on March 13, 2000 sponsored by Standard Chartered Bank. The Trustee is Standard Chartered Trustee Company Pvt. Ltd. Standard Chartered Asset Management Company Pvt. Ltd. is the AMC which was incorporated with SEBI on December 20, 1999.
HSBC ASSET MANAGEMENT CO. LTD.
HSBC Mutual Fund was setup on May 27, 2002 with HSBC Securities and Capital Markets (India) Private Limited as the sponsor. Board of Trustees, HSBC Mutual Fund acts as the Trustee Company of HSBC Mutual Fund.
HDFC ASSET MANAGEMENT CO. LTD.
HDFC Mutual Fund was setup on June 30, 2000 with two sponsors namely Housing Development Finance Corporation Limited and Standard Life Investments Limited
KOTAK MAHINDRA ASSET MANAGEMENT CO. LTD:
Kotak Mahindra Asset Management Company (KMAMC) is a subsidiary of KMBL. It is presently having more than 1, 99,818 investors in its various schemes. KMAMC started its operations in December 1998. Kotak Mahindra Mutual Fund offers schemes catering to investors with varying risk - return profiles. It was the first company to launch dedicated gilt scheme investing only in government securities.
Prudential ICICI Mutual Fund
The mutual fund of ICICI is a joint venture with Prudential Plc. of America, one of the largest life insurance companies in the US of A. Prudential ICICI Mutual Fund was setup on 13th of October, 1993 with two sponsorers, Prudential Plc. and ICICI Ltd. The Trustee Company formed is Prudential ICICI Trust Ltd. and the AMC is Prudential ICICI Asset Management Company Limited incorporated on 22nd of June, 1993
Mutual funds, as the name indicates is the fund where in numerous investors come together to invest in various schemes of mutual fund.
Mutual funds are dynamic institution, which plays a crucial role in an economy by mobilizing savings and investing them in the capital market, thus establishing a link between savings and the capital market.
A mutual fund is an institution that invests the pooled funds of public to create a diversified portfolio of securities. Pooling is the key to mutual fund investing. Each mutual fund has a specific investment objective and tries to meet that objective through active portfolio management.
Mutual fund as an investment company combines or collects money of its shareholders and invests those funds in variety of stocks, bonds, and money market instruments. The latter include securities, commercial papers, certificates of deposits, etc. Mutual funds provide the investor with professional management of funds and diversification of investment.
Investors who invest in mutual funds are provided with units to participate in stock markets. These units are investment vehicle that provide a means of participation in the stock market for people who have neither the time, nor the money, nor perhaps the expertise to undertake the direct investment in equities. On the other hand they also provide a route into specialist markets where direct investment often demands both more time and more knowledge than an investor may possess.
The price of units in any mutual fund is governed by the value of underlying securities. The value of an investor's holding in a unit can therefore, like an investment in share, can go down as well as up. Hence it is said that mutual funds are subjected to market risk. Mutual fund cannot guarantee a fixed rate of return. It depends on the market condition. If the particular scheme is performing well than more return can be expected.
It also depends on the fund manager expertise knowledge. It is also seen that people invest in particular funds depending on who the fund manager is.
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested by the fund manager in different types of securities depending upon the objective of the scheme. These could range from shares to debentures to money market instruments. The income earned through these investments and the capital appreciations realized by the schemes are shared by its unit holders in proportion to the number of units owned by them.
Thus a mutual fund is the most suitable investment for the common person as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
THE FOLLOWING DIAGRAM SHOWS
THE WORKING OF MUTUAL FUND
This diagram signifies the importance of Mutual Fund.
Thus a mutual fund is the most suitable investment for the common person as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
Since small investors generally do not have adequate time, knowledge, experience & resources for directly accessing the capital market, they have to rely on an intermediary, which undertakes informed investment decisions & provides consequential benefits of professional expertise.
The advantage of Mutual Funds to the investors is professional managed, low transaction cost, liquidity, transparency, well regulated, diversified portfolios & tax benefits. By pooling their assets through mutual funds, investors achieve economies of scale.
A collected corpus can be used to procure a diversified portfolio indicating greater returns has also create economies of scale through cost reduction. This principle has been effective worldwide as more & more investors are going the mutual fund way. This portfolio diversification ensures risk minimization. The criticality such a measure comes in when you factor in the fluctuations that characterize stock markets. The interest of the investors is protected by the SEBI, which acts as a watchdog. Mutual funds are governed by SEBI (Mutual Funds) regulations, 1996.
Mutual Fund Structure in India
The above diagram gives an idea on the structure of an Indian mutual fund.
Sponsor is basically a promoter of the fund. For example Bank of Baroda, Punjab National Bank, State Bank of India and Life Insurance Corporation of India (LIC) are the sponsors of UTI Mutual Funds. Housing Development Finance Corporation Limited (HDFC)and Standard Life Investments Limited are the sponsors of HDFC mutual funds. The fund sponsor raises money from public, who become fund shareholders. The pooled money is invested in the securities. Sponsor appoints trustees.
Two third of the trustees are independent professionals who own the fund and supervises the activities of the AMC. It has the authority to sack AMC employees for non-adherence to the rules of the regulator. It safeguards the interests of the investors. They are legally appointed i.e. approved by SEBI.
Asset Management Company (AMC) is a set of financial professionals who manage the fund. It takes decisions on when and where to invest the money. It doesn't own the money. AMC is only a fee-for-service provider.
The above 3 tier structure of Indian mutual funds is very strong and virtually no chance for fraud.
A Custodian keeps safe custody of the investments (related documents of securities invested). A custodian should be a registered entity with SEBI. If the promoter holds 50% voting rights in the custodian company it can't be appointed as custodian for the fund. This is to avoid influence of the promoter on the custodian. It may also provide fund accounting services and transfer agent services. JP Morgan Chase is one of the leading custodians.
Transfer Agent Company interfaces with the customers, issue a fund's units, help investors while redeeming units. Provides balance statements and fund performance fact sheets to the investors. CAMS are a leading Transfer Agent in India.
ORGANIZATION STRUCTURE of AMC's
Given the competitive nature of the industry, an efficient and effective organization structure is necessary to ensure low overheads without sacrificing performance and other asset management services. This is not easy given the diversity of the client group and their varying investment objectives. With institutional investors, the common vehicle used is to divide assets under management into various pool vehicles. Each pool represents a set of common investment objectives, asset class and geographic areas, and a client is then allocated shares in one or more pools depending on his specifications of performance target, asset class and regional interest. With retail clients, the vehicle would be the mutual fund or unit trust, which similarly specializes in specific investment objectives, asset class and geographic areas — the difference being that the allocation into the various funds is done by the retail client himself or by his financial planner.
In asset management firms, advisors generally operate in teams. The main roles include the following:
* Asset class allocator — considered the most important part of an investment, determining the amount available to a fund manager for investment and associated guidelines;
* Fund Manager — generally specializes in a region and asset class. For larger funds, there may be more than one fund manager, each responsible for a sector, country and/or client base.
* Analysts — evaluate the macro and micro information of the securities concerned and present recommendations to the fund manager. In some firms, a majority of these analysts' recommendations must be reflected in the firm's fund manager investments.
* Client Manager — primarily a marketing role more common to firms with institutional clients. Serves as liaison between the fund manager and clients.
In general, a matrix structure links the duties and functions of each of the above. Thus, asset allocators will discuss and recommend the apportionment of the clients' assets to various pools with the client managers. Depending on the clients' objectives, the client's funds may be distributed among one or more fund managers in one or more of the following areas: global equities, emerging market bonds, major currencies, etc. Similarly, the fund manager for, say the Asian equities pool vehicle, may work with several client managers who have clients with some level of investment interest in Asian equities.
The hallmark of asset management firms is their active management of a portfolio. To do this, the following aspects are generally common to most such firms:
* Strong research and rigorous fundamental analysis, both from a bottom-up (enterprise/industry focus) and top-down angle (macroeconomic focus), are critical to identify opportunities of imperfect pricing in different markets.
* Team approach to decisions — issues of research, investment ideas, investment decisions and portfolio characteristics are debated frequently; in the largest firms, daily meetings via videoconference are common.
* Quantitative Tools — used extensively to monitor performance and fine-tune asset allocation and/or investment selection.
Channel of distribution IN Asset Management Companies in INDIA:-
Components of the Asset Management Companies
Structure of the Asset Management Company
Investment Product Distributor Gatekeeper
In the United States alone, there are some 20,000 registered investment advisors whose sole job is to select the best stocks, bonds, or other securities from the open market for their clients' portfolio.
These advisors generally operate in teams either in specialized investment advisory firms or as part of a larger operation in institutions such as mutual fund companies, insurance companies, brokerage firms and commercial banks. The function is primarily fee-driven and as such, advisors need to constantly be aware of maintaining an image and reputation that would be attractive to a target clientele.
The advisor's position at the first point of the value chain highlights his dependence on every other component of the chain to reach his ultimate client, the asset owner. Marketing efforts have to be directed not just at the asset owners but at every component of the value chain, i.e., to the product architect to ensure that adequate effort is put into designing investment products which are appropriate to the advisors' skills and expertise; to distributors to ensure their awareness and willingness to identify clients for the advisor; and to the gatekeepers, investment buyers and asset owners to convince them that the advisor is best suited to select the optimal investment package on their behalf. Some or all of these parties may be in the same firm or even the same team, or exist as separate entities altogether.
The product architect is responsible for packaging financial services into marketable investment products such as mutual funds, annuities, insurance contracts, trust instruments and deposit products. This role varies in complexity depending on whether its an exclusively architectural role or one which encompasses investment advisory, architecture and distribution. The packages designed will meet the needs of the advisor who may have specialized skills catering to special classes of investors, as well as to the distributors who, depending on their distribution channel, may require the products to have varying levels of mass-appeal. Depending on the class of investors, which could range from the retail investor, high net-worth individual, corporate and governments/municipalities with their corresponding variation of 7 days to 2 year cash availability or institutional investors with long-term funds, the degree of tailoring and active management required would be different as would the need for supporting systems to monitor the portfolio's risk tolerance levels and performance.
This is the connecting link between the asset owners as consumers and the advisors as producers of investment products. The link, however, can take many forms depending on whether the sale is through direct or indirect channels, or if the distribution is internal or external. Direct channels proceed straight to the asset owners and investment managers. Examples include mutual fund companies, who through direct marketing, sell directly to individual households; insurance companies, who through their in-house agents, sell annuities to customers; or investment advisory firms who sell its products directly to pension funds and other institutional investors. Indirect channels deal through gatekeepers who act on behalf of the asset owners and investment managers to screen products. Examples include mutual fund companies selling funds through investment firms, banks or financial planners, insurance companies selling policies through independent agents, or investment advisors buying on behalf of pension fund managers. Internal distributors would encompass the entire value chain of investment management, i.e., from asset owners to investment advisors. Examples would include commercial banks buying their own internal portfolios, large corporations buying on behalf of their own retirement funds, and corporations investing their own corporate cash.
These are the financial consultants, pension advisors and planners, trust managers, etc. who operate in the interest of the asset owners and investment buyers to screen the myriad of investment products. Prominent in this field are three international firms used by the larger investors: Watson Wyatt, Frank Russell and William Mercer. Gatekeepers are largely responsible for translating the vague investment goals of these investors into an investment strategy with specific investment guidelines, and generally will also screen the performance of investment advisors accordingly. Thus, a pension fund manager may specify low risk and a certain minimum return, and the gatekeeper will convert this into specific portfolio “value at risk” (VAR) figures and allowable volatility bands, cash proportions, etc. therein. Investment packages, as presented by the distributor, who claim track records and investment styles which meet such VAR figures, will be reviewed for selection along with the investment advisor concerned. The gatekeeper will also be responsible for monitoring the performance of the advisor or fund selected to ensure their compliance with the investment guidelines set forth.
Occasionally, such monitoring may involve intensive review of the asset management firm and the implications for the client of its future strategy, e.g., when Mercury was being acquired by Merrill Lynch, the issue of whether clients could be comfortable with the firm's new management practices and organizational culture were explored.
These are organized institutions that represent large pools of asset owners to buy investment products on behalf of this group of consumers, usually at discounted prices. Examples include retirement plan sponsors, universities, local government funds, union trusts, insurance agencies and various bank trust departments. The officers of these institutions have specific fiduciary duties towards their consumers, which will dictate the returns and risk tolerance guidelines for investment of these funds. They then hire gatekeepers to help them quantify the expectations of these consumers and identify advisors who can invest the funds in accordance with such expectations.
These are the ultimate consumers of the industry; the owners of investment product. They fall into 2 categories: individuals with assets in the form of deposit instruments, direct securities, packaged products and pension fund assets; and corporate and governments, with liquid assets held in the form of direct securities or packaged products. In the past, asset management has been primarily directed at the latter type of consumer, but with increasing pressure on management fees and growing competition in the institutional market, the potential of the retail sector is becoming more relevant. This marks an important development in the behavior of the various components of the value chain, particularly among the advisors, product architects and distributors, as the expectations of the retail sector can differ from that of the institutional.
A Note on Analytical Models
Various portfolio tracking and monitoring models measure the level of actual and recommended level of risk exposure for given target returns. These models are used by the gatekeeper to translate the risk appetite of the client into quantifiable figures which the advisor, in consultation with the product architect, will use to build a portfolio. Increasingly, fund managers are also turning to these same software packages to help them track their current risk levels as well as predict their potential future performance.
While these analytical models generally do not determine asset allocation, they are a valuable performance analysis tool, e.g. in addressing issues of essential risk analysis and portfolio construction across single or multiple asset classes as well as with a mix of geographic/macro risk indicators. They can also be used to construct optimal asset allocation strategies within specific investment views and risk estimates. The following details some specific functions performed by the models:
* Examine total and active risk relative to Financial Times, Morgan Stanley Capital Index (MSCI), JP Morgan, Salomon Brothers, or any custom benchmark.
* Examine portfolio risk characteristics relative to any benchmark or market.
* Interactively measure the impact of portfolio changes on a local market and currency risk perspective.
* Identify which assets is the least and most diversifying.
* Hedge portfolio currency risk and construct hedged benchmarks.
* Analyze total and active portfolio performance over time.
* Calculate portfolio value at risk.
* Evaluate complex portfolios, including short positions and simulated index derivatives, if such instruments are allowed in the guidelines
Working In ASSET MANAGEMENT FIRMS/ COMPANIES
Institutional vs. Retail Clients
In the past, the client base of the asset management industry has been primarily institutional, i.e., directed at the investment manager. The administrative cost of managing funds meant that only very large investors provided necessary economies of scale for the industry. As the industry became more competitive, however, management fees have been pushed down. At the same time, expectations for higher levels of service, information, records and performance have increased infrastructure costs.
Technology improvements in information management have meant that the systems required to service these large investors can now easily accommodate even small investors at relatively low overheads. With the explosion of self-managed pension plans in the USA and the increasing participation of individual investors, the potential of the retail sector has ballooned, eclipsing even some of the largest institutional pension funds. For example, at US$91 billion, the Fidelity Magellan
Fund's portfolio under management is larger than that which any asset manager may hope to receive from any one institutional investor. While there are many differences between managing institutional clients versus retail clients, the two main ones are:
i) Flow of funds: - when dealing with retail clients is unpredictable. This unpredictability is generally hidden when dealing with institutional clients as the latter manage their own flow of funds, particularly their cash positions, smoothing it out themselves as their needs dictate, and providing only set amounts to the appropriate asset manager at such times as is deemed optimal. They also select their asset managers with care, and they tend to leave their funds with a firm for at least three years before deciding, if indeed they do, to change asset managers.
Their freedom to add or redeem funds may, in any case, be restricted by the asset manager himself to certain time periods, although this largely depends on the clients' arrangement with the asset manager.
Retail clients, on the other hand, may add as and when they like, in the full expectation that their funds will be almost fully invested per the investment guidelines of the mutual fund, and may also redeem funds at will, although such flexibility may be somewhat constrained by the imposition of sales/entry or redemption fees by some funds.
ii) Performance expectations: - Performance expectations relative to peers is a greater factor with retail clients than performance relative to a bench-mark as such clients can more easily switch fund managers and often do. Investment guidelines of retail funds, therefore, are generally less restrictive and structured to allow greater risk-taking, e.g., allowing greater volatility ranges (no maintenance of a VAR figure required) and leveraging to improve performance.
Revenues and Expenses
Asset management firms derive their revenues from fees, whether they concentrate solely on the advisory end or encapsulate the product architecture, distribution and gatekeeper roles as well. Fees are generally negotiated on a case-by-case basis with each major client in accordance with their asset management needs and the size of their assets; clients with more specific and unique investment guidelines will be charged higher fees. Calculation of this fee may comprise one or more of the following methods, depending to some extent on the client's choice of performance indicator:
* flat dollar figure regardless of the average asset value
* flat percentage figure on the average asset value
* Bonus percentage points calculated on average portfolio value on performance above target figures
* Penalty percentage points on performance below target figures.
Working of Asset Management Companies
Schematic of Typical Buy-Sell Process
Funds from Institutional or Retail Investors
Asset management Firms
Allocates to various asset classes Research suggesting optimal
And/or countries allocation
Fund Manager undergoes individual Market news & dynamics
Stock/bond selection process.
Info analysis includes: Investment Guidelines
· Company visits
· Quantitative analysis
· Evaluation of research department's recommendations
Purchase or Sale of Investment for Portfolio
The above illustrates how, in the course of a normal day, asset managers undertake buy-sell activities to optimize the mix of investments in a given portfolio. Generally, however, when an investment is first entered into/bought, the strategy is one of gradual accumulation. Should the fundamentals of another investment/company look better, the strategy may change to one where new funds are used to buy this new investment, i.e., the first investment may not necessarily be sold. Generally, a sell decision on existing positions only happens when cash is needed to meet redemptions (in which case the investment with the least potential will be sold) or if the reasons for entering into the investment in the first place (e.g., strong balance sheet and earnings or a growing macro environment) have changed.
However, organizational factors can trigger a buy-sell decision not directly related to the investment's performance in a portfolio. While adherence to such ‘rules' may be waived by appeal to the funds' Trustees or a compliance committee, they nevertheless do serve to constrain the level of freedom asset managers have in buying and/or selling investments. Generally, these organizational factors fall into one of two areas as follows:
Availability of funds
Asset management firms market themselves on their active management of funds and actively solicit funds towards such purpose. Thus, once a client provides funds, these must be invested within days, particularly since management fees are charged on such funds immediately. In addition, some clients and funds may have investment guidelines stipulating a maximum cash position.
Where the clients' or funds' investment guidelines allow the asset management firm some degree of flexibility in asset allocation, the amount of funds made available to the asset manager is controlled by the asset allocation manager. In practice such decisions is largely a result of team discussions on whether and how much an asset class team (and within it, a geographic specialty) can invest effectively?
Where the guidelines are more restrictive, such flexibility within the firm will not be possible and the funds must be invested per the guidelines regardless of market conditions.
In the event market conditions are exceptionally bad, the fund manager may apply to its trustees or the compliance committee to allow the use of alternative investments (e.g., local bank deposits) until such time as the market outlook improves.
Similarly, if outflow of funds occurs so that sale of existing positions is required to meet this outflow, the fund manager will have to find investment positions to liquidate. This is necessary, regardless of how positive market conditions may seem and the consequent negative impact of such liquidations on his portfolio's performance.
Fund Management Readjustment due to breach of investment or prudential guidelines:
Various indicators are tracked at all times to monitor a portfolio's adherence to its investment guidelines and to prudential practices. Due to the constant movement of the various financial markets, a portfolio could breach one or more of its limits, such as:
* Value of a single stock within portfolio greater than maximum allowed, as when a stock has disproportionate appreciation relative to other stocks in the portfolio.
* Value of a single stock drops below the minimum prudential level (usually at least 0.5% of a portfolio's value). In such situation, the manager would have to decide to either further accumulate, thus raising the stock's value in the portfolio, or remove (sell) the stock from the portfolio.
* Portfolio's measured VAR exceeds range allowed such as may happen when a manager chooses to select non-benchmark shares to constitute a considerable proportion of the portfolio, and such stocks then experience significant price fluctuation
* Macro fundamentals change in conditions so that the investment no longer fits the criteria specified by the investment guidelines, e.g., investment-grade bonds being down-rated.
In addition, a manager also has to be aware of his trading turnover otherwise he may find himself too close or even exceeding the limit of trading turnover permitted in his guidelines. If such is the case, he would either have to restrain his buy-sell activities for the rest of the year or appeal for an increase in such turnover.
While appeals for waiver of investment guidelines can be granted, the manager is expected to present sound reasons for such and not simply carelessness in tracking his portfolio positions.
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2. Srivastava, R.M., Management of Indian Financial Institutions.
3. Bhole, L M, Financial Institution and Markets, Tata Mc-Graw Hill, New Delhi, 2007
4. Srivastava, R.M., Management of Indian Financial Institutions.