SEBI’s regulations specify how the sector is to be structured, right from the institutions that keep it running to the entry requirements for these players, as well as their roles and responsibilities. If people feel relaxed about their mutual fund investments, it is largely because of the regulatory safeguards.
For a mutual fund investor, it helps to understand the different components of the sector. As mentioned, market regulator SEBI forms regulations which govern the functioning of mutual funds. These pertain to disclosure requirements, mutual fund classifications, and investor relations, among other things. But SEBI is only one player out of many, and this article will introduce you to the many institutions that make up the world of mutual funds.
As per SEBI’s regulations, every mutual fund has a three-tiered structure. And fund houses have to disclose the details in their scheme-related document. Let’s focus on the three components of this structure.
A sponsor or a guarantor is an individual or company that launches the mutual fund. The sponsor sets up the mutual fund as a public trust under the Indian Trust Act, 1882. In simple terms, a trust is an entity created to transfer property from one person to another. In case of a mutual fund, the fund is set up to hold assets on behalf of its investors. But it is not a charitable trust. The sponsor creates the fund with the express intention of earning money.
However, not everyone can be a sponsor. The SEBI regulations specify certain entry conditions for mutual fund sponsors. As per the regulations, a sponsor must meet the following criteria:
A fund sponsor is similar to the promoter of a company.
The sponsor generally appoints a number of trustees for the mutual fund. The sponsor also creates a trust in favour of the trustees through a trust deed. These trustees are now tasked with managing the trust. This means:
Some laws applicable to the trustees are the Indian Trust Act, the Companies Act, and the SEBI Mutual Fund Regulations.
The structure of mutual funds has safeguards to ensure multiple levels of accountability. The trustees function similar to the Board of Directors of a company. And SEBI has some rules pertaining to who can be appointed as a trustee:
The AMC is the fund manager or investment manager, and it charges a fee for its services. The AMC is responsible for the day-to-day management of the fund. Here’s a look at its various functions:
To prevent the misuse of investor funds, SEBI has strict regulations about the business activities of an AMC. Here are some of them:
Apart from the sponsor, the trustees, and the AMC, some other institutions are also a part of the mutual fund ecosystem. These entities work together with the AMC to ensure the smooth functioning of mutual funds.
Even though the AMC purchases assets, it does not physically hold them. These assets are held by the custodian. Take a look at some of the primary functions of a custodian:
Some international funds make investments overseas. In such cases, the custodian plays a vital role in tracking communications that the mutual fund receives from the companies it has invested in.
The RTA forms a link between the AMC and individual investors. In case of any modifications in the folio number or information, investors have to reach out to the RTA. Let’s take a closer look at the RTA’s main functions:
The AMC sometimes provides RTA services in-house, but at other times the functions are outsourced. Many mutual funds prefer to outsource RTA functions since it is not their core competency. CAMS and Karvy are two of India’s largest RTAs for mutual funds.
The auditor checks the records of the AMC to ensure funds are being used for the reason they have been collected. Auditors certify that there is no evidence of fraud in the books.
The AMC is free to decide who to appoint as an auditor and decide on the compensation for the service. But it must follow all the rules regarding the appointment of auditors, as well as publish the auditor’s report and carry out other tasks detailed in the Companies Act.
Brokers are institutions and individuals authorised by SEBI and holding a license to operate trading accounts. They form the link between investors and the stock market. AMCs need to operate through brokers to carry out trades. Many brokers also issue research reports which AMCs use as a part of their due diligence.
Agents and distributors are an important link between the retail investor and the mutual fund. Agents recommend mutual funds to their clients and ensure the purchase transaction goes through. In return, the mutual fund pays the agents a commission.
As you can see, the structure of mutual funds is very clearly defined. There are a number of checks and balances to ensure the safety of investors’ money. But as an investor, you need to do the due diligence too. Keep in mind that not all mutual fund schemes are created equal and invest accordingly. When shopping for a mutual fund scheme, study its past performance, review its fees and charges, and check the track record of its fund manager. If you need help, open an account with a reliable broker like Kotak Securities that provides educational resources for investors of all levels. Mutual fund investment is an effective way to build your wealth, but only if you make informed decisions.
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