About a month ago, the Securities and Exchange Board of India (SEBI) had proposed that the minimum net worth of mutual fund companies be increased from the current Rs 10 crore to Rs 50 crore. The reason being offered is that fund houses should have enough capital to absorb the kind of shocks that they faced during the liquidity freeze of October 2008. However, in my opinion, this change, if it takes place will serve no purpose except to mislead investors. As an investor, you should not be under any illusion that the AMC’s capital has anything to do with making your money safer.

This argument for increasing the net worth implicitly legitimises a scenario whereby a fund house will use its own capital to either smoothen returns or provide liquidity in its funds. This is a slippery slope because it completely nullifies the very concept of a mutual fund — that it is a pass-through vehicle which simply provides investment management services to its customers. The risks and losses must be customers’ alone. The rest of the regulatory framework ensures that there is a high wall between your money invested with a fund and the fund houses’ own capital. The fund house is not your partner in investments but a separate business whose job is to provide you with investment management services for a fee. Do not be under the illusion that increasing the AMC’s net worth requirement from Rs 10 crore to Rs 50 crore will make your investments five times safer, or indeed, any safer.

And why have this particular figure of Rs 50 crore? During October 2010, if the liquidity crisis had to be managed by using AMCs’ capital alone then hundreds or even thousands of crore may not have been enough. At the time, this pass-through nature of funds was not maintained. To manage the crisis, the Reserve Bank of India (RBI) opened a special financing window for funds. Some fund houses’ parent organisations were also said to have helped. After the crisis, SEBI has tightened many rules that make debt funds better aligned to underlying markets. These changes have been well thought out and thorough. However, investors should not get the idea that if the markets freeze up again, they will have recourse to the AMC’s capital.

There is another basic flaw in the argument. If the net worth is needed to back up a fund, then surely it must be proportional to the assets being managed by an AMC. It hardly makes sense for AMCs at two ends of the size spectrum — the Rs 1.11 lakh crore Reliance Mutual Fund and the Rs 103 crore Quantum Mutual Fund — to both need Rs 50 crore of net worth. In fact, my suspicion is that the bigger fund companies are so enthusiastic about net worth being raised simply because they would like to narrow the competitive field in terms of fund performance. Some of the smaller AMCs have funds that routinely generate better returns than those from the big AMCs.

Mutual funds are generally quite a well-regulated field. Since the collapse of CRB Mutual Fund in 1996, SEBI has ensured that there’s no one in the fund business who is going to run away with investors’ money. Increasing the net worth requirement will not do anything tangible to increase investor safety. However, it will definitely increase entry barriers in a field that needs more competition.