The Association of Mutual Funds in India (AMFI) recently laid out guidelines for front-running and fraudulent transactions. The AMFI’s move, which comes nearly a month after SEBI’s nudge in response to front-running allegations against Quant MF, is an attempt to tighten regulations for better transparency. Despite the market regulator’s proactive role, mutual fund investors are always prone to such market abuse tactics.
The demon of mutual fund front-running isn’t new to the market and has often haunted investors because of its negative repercussions. Apart from Quant MF, other AMCs like Axis Mutual Fund, HDFC Mutual Fund, and even LIC have come under scrutiny over allegations of front-running activities. As repeated cases of front-running bring the onus on investors to stay vigilant and take precautionary measures, let’s understand how investors can shield their portfolios from the effects of front-running.
What is front running?
Front-running is a market malpractice opted for by insiders who use their prior knowledge of pending orders to buy or sell shares or other assets for their benefit. For instance, if an MF house broker or official leaks information about a planned trade execution in advance, then individuals can use the information to build prior positions in the trade for their benefit. The information leak can cause huge harm to other long-term MF investors.
How to guard portfolios against front-running?
While it is difficult to monitor front-running, certain precautionary measures can help investors minimise the impact of such cases on their investments. Market experts advise investors to diversify their portfolios, stay vigilant, and opt for measures like passive investment.
Diversification
Market experts believe diverse investments can help individuals with long-term or short-term investment strategies absorb market shocks caused by front-running.
“Spread your investments across various asset classes and sectors. This reduces the concentration risk and makes it harder for front-runners to target specific stocks,” said Amit Goel, Co-Founder and Chief Global Strategist at Pace 360.
Investors can also opt for a broad spectrum of sectors and geographic regions to minimise their exposure to any single market volatility, believesTarun Singh, Founder and MD, Highbrow Securities.
Vigilant monitoring
Being aware of market developments and regularly reviewing investment portfolios allows investors to track market malpractices before it’s too late. “Regular review of fund performance for unusual patterns might help investors indicate front-running,” said Narinder Wadhwa MD of SKI Capital, while highlighting the importance of choosing a fund house with strong compliance and governance.
“While front-running can be a significant concern for investors and their investments, it’s important to maintain a balanced perspective. By staying informed about market developments, conducting thorough due diligence on fund houses, and diversifying investments, investors can mitigate the risks associated with this practice,” said Heena Arora Agarwal, Founding Managing Partner, FundVice.
Passive Management
Passive investment ensures constant wealth generation over a longer period. Unlike traditional MFs, which aim to beat market returns or a specific market index, a passive index ideally mirrors the performance of a market index. Adhering to passive investment tools like index funds, ETFs, etc., is likely to reduce the chances of falling prey to front-running, said Tarun Singh.
When MFs face front-running allegations
In case the mutual fund in which investors have invested money faces front-running allegations, Narinder Wadhwa advises them to review the fund house’s response to allegations and closely observe SEBI’s action.
“Research the allegations and gather information from reliable sources. Pay attention to the evidence presented and the response from the fund house,” said Goel.