Last Updated on June 24, 2024 at 11:41 am
On June 23rd 2024, Moneycontrol reported that SEBI conducted search and seizure operations at two locations of Quant Mutual Fund on suspected front-running. In response, the AMC has confirmed via email to investors that it has received inquiries from SEBI but has not added more information.
At the time of writing, information on this (first, how true these allegations are, and if so, to what extent) is not known. It is not yet known for sure if the SEBI enquiry is for front-running and/or any other issue. Anger at the fund managers or the fund house will not help us much and will likely lead to bad decisions. So, let us consider the facts calmly.
Front running (in the current context) is when AMC employees or their associates, brokers, etc., buy shares in their personal account(s) or leak information before a fund purchases the shares. Since the fund would place a large order, the price will move up. So, those who purchased shares with the leaked information would get an immediate gain that can be sold off. Naturally, this is illegal and unethical and is banned by SEBI.
The lower the stock’s market cap, the higher the price boost (aka impact cost). We have already pointed out that the bid-sell price difference can quickly increase beyond the top few stocks. Warning! Even large cap stocks are not liquid enough! Can you handle this?
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Will front running affect mutual fund unitholders? Yes. The personal orders by the fund manager and associates can be large enough* to drive up the price before the AMC buys the stock. *If it is not large enough, why would the matter come to light?!
Naturally, now, many investors may want to exit. This could cause redemption pressure and affect the NAV. Some market players may short the large holdings of the fund house. No one can predict what will happen. My guess is that redemptions will increase, but it may not be so high to affect the NAV too much. Things should settle down in a few days. For now, the fund manager can use the cash equivalents or large cap stock to handle redemptions.
Is front running common in India? Even if we go by the cases that have come to light, they are extremely common! It is, after all, human behaviour to profit from information that only a few people know about. See for example: Sebi slaps Rs 15 crore fine on Sharekhan, others over front-running activities.
Is front-running common in Indian mutual funds? Even if we go by the cases that have come to light, they are extremely common!! Here are some news stories on mutual fund front-running cases. The punished individuals include fund managers and brokers/agents associated with mutual funds.
- Reliance mutual fund: Sebi bans 3 individuals for 6 months in front running case (May 2021)
- IIFL AMC suspends service of employee caught by Sebi in front running case (Oct 2020)
- HDFC AMC front-running case: SEBI settles case with 2 entities (Sep 2019)
- A fund manager of Deutsche Mutual Fund and his parents paid nearly ₹ 5 crores to settle with SEBI a case of alleged front running in mutual fund trades (Dec 2021)
- Tata AMC with dealers (not employees) being guilty: SEBI unearths front-running racket by dealers at Reliance Securities (Aug 2020).
- May 2022: Axis MF front running: What should investors do?
Is this similar to what happened at Franklin Templeton MF? That can be classified as insider trading rather than front-running. See: Some Officials Redeemed Investments Before Winding Up, Shows Audit.
Will unitholders be compensated for these illegal actions? Yes, if SEBI deems fit. For example, HDFC Mutual Fund compensates investors for front-running losses. But it may take years, and compensation would likely be minuscule!
Does front running happen with index funds? Yes, but it is not illegal as which stocks will enter or leave an index is public information.
The official information is not enough to ascertain the width and depth of the situation. Unsatisfactory as it may be for the reader/investor, it would be imprudent and irresponsible on our part to recommend a simple “exit” or “stay” based on the information available at the time of writing.
Mass redemptions can cause bigger problems for both the fund house and investors, especially in funds holding a good amount of mid cap and small cap stocks.
That said, we can only urge individual unitholders to do what would give them peace of mind. Although the current scale of the problem is unknown, if we go by past front-running cases, then waiting and watching (if not staying put) is not a terrible idea.
Note: I am not a Quant MF investor. So it is easier for me to write this! But if I were, I would wait and watch with my existing units wait for clarity before I put in fresh money.