In a
circular released on 20th February by SEBI, the securities markets regulator has done away with the archaic norms restricting the investments that Mutual Funds can make in derivatives. The previous rules, in place since 2005, required schemes whose Scheme Information Documents didn't envisage derivative investments to "obtain positive consent from majority of the unit holders before commencing investment in derivatives". With the number of unit holders running into lakhs in many schemes, this rule had joined the ranks of the ornamental.
Derivatives comprise of futures and options, and are used either for speculation or for hedging. Currently, the use of derivatives is most pronounced in arbitrage mutual funds, which simultaneously buy securities in the spot market and sell their futures in the derivatives market, locking in a riskless profit in the process. Retail investors generally have a poor understanding of how the derivatives markets operate.
"In view of prudent investment norms that are in place for investment in derivatives by Mutual Funds, it has been decided that for introduction of derivative investments in an existing scheme, whose SIDs do not currently envisage such investments, the requirement of obtaining positive consent from majority of unit holders shall no longer be applicable", the circular states.
The circular adds that all investors in the scheme in question will be given a load-free exit option for a 30-day period, should it decide to commence trading in derivatives. Additionally, risks need to be suitably explained and illustrated, along with numeric examples.
Famously described as "weapons of mass destruction" by the iconic Warren Buffett, derivatives can significantly add to or reduce risks associated with one's investment portfolio, depending upon how they used. The question that arises is - how should a retail investor react, if informed that their trusty old mutual fund now plans to partake in them?
The simple answer would be to stay put and not worry. There are stringent norms already in place in our country regarding Mutual Funds and derivative usage - for instance, restricting or disallowing risky tactics such as naked short selling or leverage. It's likely that most schemes will use derivatives as a hedging tool rather than to speculate - choosing to err on the side of caution rather than adopting a more buccaneering approach. Additionally, it's near impossible that risky derivative strategies would make it past the robust risk committees that top fund houses employ. It's even more unlikely that Fund Managers would take on the sizeable career risk associated with a directional bet going awry and leading to the funds slippage in the ranking tables that are so diligently published every quarter, and so religiously consumed by internet-savvy investors!
End Note: while the amendment does open options for fund houses, retail investors in existing schemes needn't worry. This really is quite a welcome move that could benefit investors eventually.
