Impact of Regulation Regimes on Fund Performance - Essay Example

The impact of different regulation regimes on funds performance Number: Paper: The impact of different regulation regimes on funds performance Abstract The essay highlights the usefulness of fixed income securities in contemporary world. There are many investment options in the global financial market, which can fetch good return to the investors. However, few are associated with high and low risk. The asset allocation for the different investments varies according to the risk type of the investment. Through this investments are risk of investing in one sector is minimized as the funds invests the amount invested by the investor in different sectors; as a result the risk gets distributed and the probability of losing money in the volatile market is reduced. The fixed income securities have the ability to provide regular income, stability and liquidity to the investors and as a result the investors prefers in investing in this kinds of funds. With the advent of these funds investors are relying on its investment as risks are relatively reduced as they receive a fixed dividend after a specified period of time. There are numerous benefits for investing in fixed income securities, which attracts the investors to invest in it. The rules and regulations pertaining to the investments are stringent, which restricts groups of people in investing in these funds. For investing in few fixed income securities registration is required, which becomes a hindrance for common investors. However, the government of individual countries have reduced the compliance burden to a great extent. The retirement fund administrators have to obey the strict legislation the requirements related to the governance of the fund. A personal statement is provided in order give the view of the writer regarding the operation of fixed income securities. Introduction Fixed income securities are securities, which are defensive in nature and have the capability to provide capital stability, liquidity, income and diversification to the investors. It provides capital stability to growth-oriented asset classes, such as, property and equity. In spite of the advantages portrayed by the fund, it has limited use worldwide. As for example, the investors in Australia do not use this particular fund as fixed income investment, instead they employed other managed funds over the past 23 years. Within this time frame, a proportion of investor’s wealth is allocated to fixed income securities present in Australia. The investments in fixed income funds had, however, declined over the years. During this period of time, the investment made in equities had increased as it is made in cash. Hence, it can be portrayed that irrespective of definite advantages of the fund, it was rarely used by the investors (Cornett and Saunders 156). There are many reasons behind slow allocation of investment in the fixed income fund worldwide. Firstly, the investors of few countries, such as, Australia, are comfortable with investing in equity. Owing to the stable dividend rates and higher payout ratios of equity, the Australian investors are reluctant to invest in any other asset classes other than fixed income fund. Likewise, few other countries follow the same portfolio allocation as that of Australia. However, it is evident that the investment made in these funds has increased in other countries like, the United Kingdom, United States and India, over the years due to higher demand for fixed income. The advantages of fixed income fund are well exploited by the investors of the above mentioned countries (Kapoor 258). Different countries have separate regulation for managing functions of the fixed income funds. The regulations give emphasis on restricting the use of funds and its operation. Hence, the research paper underlines effect of the regulations on function of the fixed income funds (Jarrow 25). The following paragraphs highlights on the structure and types of fixed income funds, along with its performance. There are many benefits for investing in fixed income funds, which are discussed in the literature in order to help the reader understand importance of the fund. Moreover, it also lays emphasis on the effect of regulations on performance of the fixed income funds. Benefits of investing in fixed income fund The fixed income bonds or securities play an important role in framing a diversified portfolio. The following are the benefits of investing in fixed income securities: Capital preservation: The fixed income securities aim at providing capital stability to the investors. The principle is paid to the investors after maturity of the securities. When the investment is combined with strong credit worthiness, the fixed income issuers are determined to receive effective capital preservation. The government fixed income securities are backed by credit and thus, it is easy for the sovereign government securities to raise capital through investment. Income stream: A majority of the investment is made in fixed income securities as it provides fixed interest and income. The securities aim at offering the investors with a reliable flow of income at regular intervals or at maturity of the security. The dividends paid to the investors are modified across a number of portfolios according to the prevailing rate of interest. Store of liquidity: The fixed income funds are regarded as a store of liquidity. As a result, several central banks worldwide exchange cash for collateral transaction of fixed income by implementing monetary policy. The banks also act efficiently for stabilizing the turbulent markets. The small investors can access liquidity of the fixed income fund as it is cost effective in nature and is subject to exit and exit transactions on a regular basis (“How to Assess Going Concerns”). Diversifying risk: Fixed income funds are regarded as defensive assets, which have the ability to reduce the risk in obtaining higher returns. The returns of fixed income funds are less volatile than that of equities, which are also negatively correlated. Hence, the returns of fixed income securities reduce the chance of obtaining negative returns across a number of broad portfolios (Tuckman 34). Structure of Fixed Income Fund The structure of fixed income fund can be divided into two parts: umbrella and global fund. The umbrella fund has similarity with a pool of funds or unit trust, which allows a number of employers to add to the same pool. The cost associated with the funds, along with its administration charges, are shared by the employers who offer funds to the employees. This particular fund is appropriate for those employers who do not qualify to implement the cost for stand-alone retirement fund. By accumulating the assets, the employers gain advantage from economies of scale and simultaneously lower the average cost applied to each member. Besides the reduction in cost, the pool of efforts aims at reducing burden of the management and improving governance and compliance. These funds are operated so as to earn profit for the product and service providers who are associated to the fund sponsors. In this context, sponsors are the asset managers, retirement fund managers and the insurance company (Madura 58). There are basically two types of umbrella fund structures. The first structure depicts the full composite services that are needed to operate the fund such as, consulting, reporting and administration. This structure is offered by single service provider, along with participating employers, who play a passive role in the whole structure (Robert 235). The second structure represents the framework where employers have an active role in outsourcing the services to a number of service providers. However, in this particular structure, professional relationship is maintained with the employees (Whale 147). The main advantages of umbrella fund are as follows: Independent governance: These funds are managed by experienced and independent Board of Trustees. The funds are restricted by strict legislation and governance. The functions of trustees are handed over to the professional teams of investment experts and trustees for reducing compliance, administration and governance burden that are levied on the employers. Cost effective: After the assets are polled, the employers are benefitted from economies of scale. They even get the opportunity to negotiate with the fund managers for more competitive fees. Simple to set up: There are a number of financial service providers (FSPs), which offer umbrella funds such as, FundsAtWork, Old Mutual and Liberty and Sanlam. The employers are able to select the funds, which would provide provision for the risk benefits, thereby saving the employers’ time and other resources required for setting up and managing complex arrangements of retirement funds (Nystedt 12). The primary investment objective of this fund is to provide the investors with fixed annual rate of return. The fund structure makes it easily accessible for the investors. The umbrella funds are defined as the bargaining funds for franchise holders of particular commercial groups and also as commercial funds that are sponsored by the fund administrators and insurers. Impact of regulation on umbrella fund structure The one and only regulation pertaining to umbrella funds is the Pension Fund Act. This regulation forms a part of Section 7B of the Act and serial number of the regulation is 30(2) (t). It is known that Section 7B permits the registrar for exempting the umbrella fund from the required members who are elected on the Board. The criteria for the exemption are set in circular number, PF96, which is issued by Registrar. The regulation 30(2) (t) takes into account the rules pertaining to umbrella fund that are specified for the employers. These rules enable the umbrella fund to distinguish itself from others. The officials of the financial services boards are engaged in discussing and drafting representatives of the industry regarding the different regulations related to umbrella funds in the article, Supervision of Umbrella funds. However, the draft is not present before the parliament. There have been many critical reviews against the umbrella funds in recent years. These are related to perception of the individuals regarding the cost and governance, which is not satisfactory. The reality related to the umbrella funds relates to savings that are earned from the competitive retirement solutions. These funds are basically developed for valuing individual needs of the members and participating employers. Other than increasing governance and economies of scale, the umbrella fund has important characteristics such as, detailing innovative communication framework and supervising prudential management. Being a packaged solution, umbrella fund is inclined towards offering a cost effective way to save money post retirement. The funds allow the employers to provide employees with a wide variety of benefits. These employees are already the members of larger retirement fund. The fund also acts as a starting point for the employees of small companies, who do not form part of any savings mechanism. The members of the umbrella fund share the market related risks collectively, in terms of the cost linked with administration of the fund. These risks are associated with banking charges and service fees. The members are able to save huge amounts even by contributing meagerly (Kwok 45). The reduction in burden of compliance is observed in this type of fund. The retirement fund administrator is bound to obey strict legislation and abide by the requirements pertaining to governance. As a result, management of the umbrella funds is handed over to the investment experts and professional teams of trustees. This act aims to reduce administration, governance and compliance on the employer’s part as well as accounts for transparent reporting of the investment performance. This particular fund structure enables the sponsor and employer of the companies to focus on the individual core businesses. The critics of umbrella fund do not concentrate on the fact that Sponsor Company has a framework for providing information so as to communicate the net replacement ratio and the benefit statements of a member. The same framework is employed for dealing with the queries of a member. The funds are developed by considering interests and education of the members, which the sponsor company helps to build on behalf of the fund managers. Particular charts are prepared that signify progress of the funds towards the retirement period. Global fixed income funds aim at maximizing the total return and invest 70% of total assets on fixed income securities that can be transferred and denominated into several currencies that are issued by the agencies, government and companies operating worldwide. The \range of securities comprises non-investment grades and currency exposure is managed wisely. The main investment objective of the fund is to invest without any restriction. The investment includes commercial papers that are backed by assets, collateralized debt obligations, commercial mortgage backed by securities, credit linked notes and real estate mortgage (Gupta 23). The underlying assets include leases or receivables and loans. The fund may employ leverage in order to improve its return to the investors. The funds are structured by employing derivatives such as, credit default swap, which are used for gaining exposure to performance of the securities offered to various issuers (“The importance of a going concern”). Impact of regulation on global fixed income fund structure The global fixed income fund is more influenced by the requirements of trade reporting and record keeping as compared to that of securities traded publicly. The funds are also subject to several restrictions stated by the regulations. The regulations constitute restrictions for a number of investors of each fund. In particular, the global funds are classified under Regulation D related to Securities Act of 1933. This particular regulation elaborates on collecting capital with the help of non-public offerings and also from the individuals or accredited investors whose investment net worth amounts to about $1,000,000 or has a minimal income amount of approximately $200,000 in two years. A reasonable amount of investment should be made in order to reach the same amount of income (Duarte, Longstaff, and Yu 770). Security Exchange Commission (SEC) had provided explicit authority for adjusting income standards and net worth of the individuals or investors, whenever deemed appropriate. If the banks and corporate want to invest in these funds, then they must invest a minimum amount of $5,000,000 through total assets.  There are huge numbers of global fund investors who need to reach the standard for qualifying Investment Company Act of 1940. This act generally takes into account individuals with the ability to invest around $5,000,000 and $25,000,000 as investment in the pension plans (Brouthers 26). The global funds are restricted by Investment Company Act of 1940 to make public offerings, which are also subject to anti-fraud provisions that form part of the Securities Act of 1933 and 1934. Several global funds operating in the United States are managed by the Commodity Futures Trading Commission (CFTC), including the advisers who are registered under Commodity Trading Advisors (CTA) and Commodity Pool Operators (CPO). These funds are governed by the CFTC in the global market as well as by Commodity Exchange Act. The global regulatory landscape had recently developed that has followed the passage of Dodd Frank Act, which has set new registration and other necessary requirements for the global fixed income funds (Hanif 96). Equity fund is defined as a private investment fund that aims at purchasing ownership in terms of businesses. The ownership comes in form of publicly traded stocks in renowned companies. In other cases, the ownership is in form of private equity, which defines investment in equity in the private companies that do not trade in the stock market. There are different types of equity investment such as, international equity, mega, mid, micro and large cap equity and private equity fund. The international equity funds are defined as those directed at investing in stocks outside borders of the United States. The global equity funds are defined as the funds that invest in the stocks available worldwide (Fung and Hsieh 20; Loudon, Okunev and White 50). Money market funds defined as open-ended funds that aim to invest in the short-term debt securities such as, commercial papers. They are regarded as safe as bank deposits, which yield higher return as compared to that of other funds. It basically seeks to restrict exposure to money loss that occurs due to market, liquidity and credit risks. The money market funds are regulated by SEC in the United States and are registered under the Investment Company Act of 1940. The rule pertaining to the act restricts maturity, quality and diversification of investment. The fund mainly purchases high rated debt that has maturity in 13 months. However, the portfolio maintains the weighted average maturity for 60 days or even less and does not invest more than 5% (Grinblatt, Titman and Wermers 1090). Regulation for fixed income funds Fixed income funds are subject to restrictions in the securities market and are exempted under the Securities Exchange Act of 1934. So, the government securities are not devoid of regulations. These regulations are passed in order to protect interest of the investors and to assure that a fair trade takes place in the liquid market. The regulatory regimes are established for governing actions of the brokers and dealers (Getmansky 530). The regulations give emphasis on capitalization of the dealers and brokers who are associated in trade and also concentrate on developing and implementing rules pertaining to the transactions in government securities. For other entities prevailing in the market, enforcement of these regulations is often delegated to the regulatory agencies or self-regulatory organizations that already share a relationship with the entities. The fixed income funds are marketed as the Treasury securities in primary market by conducting scheduled auctions regularly. Participation in these auctions is not limited to the registered dealers. Moreover, the auction bids are encouraged by large and diverse groups of entities and individuals (Sharpe, Alexander and Bailey 145). The regulatory and legal framework followed by the fixed income funds are elaborated henceforth. Regulations are formulated in order to facilitate changes in present conditions of the financial markets. In order to give shape to the regulations and make it effective, a particular framework is created. In the United States (US), regulation for the fixed income market and its various segments is ascertained by way of employing the US legal structure, along with tax codes, regulatory and financial history of the US (Lhabitant and Learned 30). The regulations in the fixed income market help to pool a large investor base that can effectively evaluate the market and credit risk of a particular market by following the specific accounting standards such as, US GAAP and IFRS, as well as corporate law (Du, Huang and Blanchfield 380). The regulations for the fixed income securities are highly dependent on nature and type of the issuer and the product offered. The regulations have affected performance of these funds even though it is formulated for protecting the investors’ interests. It has the ability to reduce the rate of return on the date of maturity. The regulations have also restricted the use of these funds by all investors universally. The initial investment amount is a constraint for many individuals. If the fund is redeemed before the date of expiry, then the investor has to pay a penalty on the amount. This rule forms part of the regulation, which is detailed by the Securities Act 1934 in the theory of disclosure. The theory of disclosure is disclosed by the issuer so that all investors are able to gather adequate information regarding the investment in fixed income funds. This information is expected to be relevant to the investors so as to help make investment in these funds. The investors are not provided with information pertaining to the merits of investing in a particular security or issuer, which is why the investment decision is under the former’s discretion. For disclosing the information, the issuer has to abide by the rules and regulations of the security exchange (Calvet 47). As a result, the disclosure-based system is a disadvantage for issuers and it acts as a disinfectant. These regulations have restricted performance of the fixed income fund by way of limiting the rate of return. Limited information is provided in the disclosure presented by the issuer because of the legislation. Consequently, investors are not able to obtain complete details pertaining to the fund wherein they prefer to invest. Hence, the investors require undertaking the entire responsibility of the decision regarding investing in the funds. With fall in performance of the fund, the investors are reluctant to invest, thereby leading to lower rate of return. Therefore, performance of fixed income funds is affected by the regulations that are devised by the market (“Going Concern Concept”). There are a number of securities that neither follow the legislations nor comply with requirements of Section 5 of the Security Act 1934. The securities comprise the government bonds and they overlook the legislation due to support of the government itself. These bonds give fixed returns that are beneficial to the issuer and investor as performance is expected to improve with the provision. These approvals are made by the government, which in turn assures the investors in terms security in making investment in such a fund. The bank supervisors and the regulatory authorities do not play any role relate to the fund performance. There also several other funds that are issued by financial institutions. These funds are investment grade securities, which mature in less than a year. The debt securities are used extensively and are not issued for investment purpose primarily. The municipal debt securities are exempt from registration under the Securities Act; however, the security has to comply with antifraud provisions of the securities laws (Ferson 486). Additionally, the Securities Act 1934 provides exemptions for registration on certain transactions. Most importantly, exempt transactions comprise private placements that are provided to a restricted number of purchasers. The exempt transactions also take into account private placements that are offered to the accredited or sophisticated investors. According to Regulation D of the Securities Act 1934, issuers offer unlimited amount of securities to the qualified investors who are appropriately registered. Hence, these investors are supplied with adequate specific information either through advertisements or general solicitation. Generally, a private placement constitutes offerings that are made through numerous blocks of securities accredited by the institutional investors. These types of placements are employed by companies that frequently provide debt securities. These debt securities assure fixed income to the investors, which prove more convenient than other securities (Lamm 10). Internship is a very vital part of every student’s life during the Master’s course, in terms of shaping up one’s career. It provides the student with an opportunity to contribute to an organization and experience work life, which would be a new reality. The internship program has allowed me to participate in the operations of a private bank and understand every minute detail related to the financial services available with the same (Sedzro and Sardano 1130). The financial services offered to the customers must be managed by the bank personnel so as to satisfy their needs. As a result, client accounts management department is one of the essential sections in the private bank wherein I had interned. The bank managed investments of the customers in different securities such as, fixed deposits, mutual funds and many others. I had joined this department for an internship program as I desired to experience the way in which a customers’ relationship manager manages performance of the funds. I had selected the fixed income securities as my area of study in the internship program. My choice is based on the fact that fixed income securities are the most secured way to invest for any investor. Investors regularly use these funds for making investment. Nonetheless, the most interesting part of the investment lies in rules and regulations that are followed (Sundaresan 234). Result The regulations are stringent and according to the Securities Act 1934 and SEC, all investors are not allowed to invest in fixed income funds; there are certain limitations pertaining to registration of the investors. These regulations have lowered the number of investments that have indirectly affected the level of capital accumulation made by asset management companies. The theory related to the regulation of fixed income securities has highlighted on the stringent procedure set by the SEC directed at the financial institutions and investors so as to protect their mutual interests. The impact of regulation is observed in performance of the funds as all individual are not permitted to invest in the fixed income securities. The individuals are very particular regarding their investment category. As a consequence, they secure their money by investing in such funds. Therefore, I have learnt that it is very important for an individual investor to track the needs of securities acts and prepare the demand for particular portfolio. 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