Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

SEBI Report on Dedicated Infrastructure Funds

The Securities and Exchange Board of India has published the Report and
Recommendations of the Committee on Launch of Dedicated
Infrastructure Funds by Mutual Funds

I have been a firm supporter of allowing domestic hedge funds,
private equity funds, real estate funds and other alternative
investment vehicles. I would also welcome retail access to these
products with appropriate risk disclosures. Thus in principle, I have
no problem with the proposed Dedicated Infrastructure Funds. My
difficulty is that the report does not justify why an exception should
be made only for infrastructure funds while keeping the lid shut on
all other alternative investment vehicles.

From the perspective of a securities regulator, the justification
for a retail product has to be in terms of the risk-reward profile
that the product provides to the investor. The report is silent on this
and talks only about the need for infrastructure for the economy. The
most depressing statement in the report is the statement in the report
that:

The nature of infrastructure projects … will include a gestation
period where the project could be loss making. Thus, the NAV
performance of the [Dedicated Infrastructure Funds] may suffer during
the initial periods. This could have a negative impact on the listed
price and generate adverse reactions from investors who exit
early. Hence providing a listing window of 24 months will help the
[Dedicated Infrastructure Fund] to deploy a substantial portion of the
funds as well as some investments might move beyond the initial
construction / build-out period.

To my mind, this amounts to cheating the investors by deliberately
concealing information from them. In a rational market, investors
should be trusted to understand that there will be losses in the
gestation period. If they do not, then they are not appropriate
investors for the fund.

I strongly believe that permitting retail access to a financial
products should be based primarily on whether the product fulfills an
investor need and only secondarily (if at all) not on whether it
fulfills the need of the issuer (infrastructure developer in this case)
or the intermediary (the mutual fund in this case).

I also think that it is far better to liberalize regulations across
the board to provide investors access to a wide range of financial
products than to make an exception for one special interest group. The
regulatory goal has to be to increase innovation, competition and
market completeness. That calls for a wide range of alternate
investment vehicles.

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