Is mutual fund safe?

To some extent, every investor wants to protect his capital and at the same time, looks to earn a high return from the investment. The entire drive towards mutual funds has caused several people write in to ask if it is safe to invest in them. I don’t think safety is a criterion, as perceived by investors, it is something that mutual funds meet. Every interesting advertisement about the virtues of mutual funds ends with the end note disclaimer that investing in mutual funds is subject to market risks. Basically, investments in mutual funds do not guarantee capital preservation.

At the same time, there are several safeguards built into the system to protect the interests of investors who invest their money in mutual funds. First and foremost, the capital market regulator, Securities and Exchange Board of India (Sebi), which regulates MFs, is a critical entity in protecting investor interest, be it by drafting regulations or monitoring their implementation. It has laid down guidelines for all constituents of a MF – sponsors, trusts, asset management companies (AMCs) and custodians. The distributors selling mutual funds are also regulated by the SEBI.

Coming back to safety, if the question is about investor safety, regulations pertaining to sponsors and trustees are crucial. For instance, to be the sponsor of a MF, there are prerequisites that one needs to follow diligently as stated by the regulator. Basically, overnight one cannot float an AMC in the country besides the need for experience, adequate capital, track record and more. All of these should give investors comfort. Yet, chances are investors are wired to link safety to returns and be stuck right there.

Take for instance the board of trustees, which is set up by the sponsor, also aims to protect investor interest. At least two-thirds of the directors on the board are required to be independent. This helps in maintaining an independent stance, albeit slightly tilted in favour of investors. Trustees also monitor fund performance and compliance with SEBI regulations. This is again something that should be seen by investors as a safety net. But, more often an investor would rarely be seen worry over these aspects.

On the contrary, many would treat putting money in a multi-level Ponzi as being safe because the distributor or agent of the scheme is willing to guarantee returns even when he does not mean it in its true sense. It is also a different matter that such schemes do not follow any regulations, which makes them highly unsafe – yet people throng to such schemes because they hear the word guarantee being mentioned, but do not do the necessary diligence to note if these investments are safe.

Going back to mutual funds – these are professional managed, each AMC has its own internal risk management teams comprising risk analysts, who monitor risks and keep them in check. Investors need to move away from their block of looking for guarantees in returns and increase their awareness about financial products, their features, which is where mutual funds score over the rest handsomely. 

nk@outlookindia.com