Mutual Funds have been rapidly becoming the investment instrument of choice, especially among the millennials and the Gen Z. The convenience of starting and the ease of tracking the fund performance are cited as two of the biggest reasons for the popularity of mutual funds. The mutual fund organization is a seamless entity which aims to trade in stocks, bonds and other securities in order to maximize the returns for its investors. This organization contains several directors, advisors, fund managers, market analysts, researchers and custodians.  If you have been investing in mutual funds as well, then you are bound to have heard or read the term ‘mutual fund custodian’. In this blog we will explain the definition, roles and responsibilities of the custodian of a mutual fund.

What is a Mutual Fund Custodian?

The need for a mutual fund custodian arose due the federal government’s mandate. As per their regulations, it was obligatory to maintain segregation between the fund assets, the fund manager and the investment advisor or consultant. This was to ensure safety, transparency and to avoid any misuse or abuse of authority and access. Thus the role of a mutual fund custodian was created  to safeguard the interest of the investors who have contributed to the assets of the mutual fund.

This custodian of a mutual fund can be in the form of a financial institution, a bank, credit unions or a trust company. This is mainly because these types of institutions are already heavily regulated by federal authorities and highly streamlined with relevant internal processes (like auditing, record keeping, reporting, etc.), hence it is in everyone’s interest to give them the custody of the fund’s assets.

Roles and Responsibilities of a Mutual Fund Custodian

As already mentioned below, the primary responsibility of the mutual fund custodian is to guard and protect the securities and other assets under the mutual fund’s purview. In order to carry out this large responsibility there are several  intrinsic tasks involved. These include:

Keeping detailed records of all transactions with regards to the mutual fund assets.

Under their regulatory capacity, they also ensure precise and up-to-date information regarding the different share / unit holders and their individual data as provided to the fund house.

For all sales or purchases of the assets, the reconciliation of money provided and the confirmation of the equivalent amount of shares / units transferred to the right investors (or their brokerages, as the case might be), is also the responsibility of the custodian of a mutual fund.

The Security Exchange Commission (SEC) is the chief regulatory authority in all matters conserving the trading market, and in accordance with their compliance mandates, the mutual fund custodian is expected to make periodical reports and communication in the desired format.

Furthermore, as per SEC guidelines, the mutual fund custodian also acts as the ‘all-seeing eyes’ and monitors the reports, performance and activities of the different companies in which the mutual fund assets are being invested.

The custodian may also manage the payment of fund expenses related to the purchase or sale of units / shares, such as transaction fees, and conduct the redemption process.

Additional Services Offered by Mutual Fund Custodians

Let us not forget that mutual fund custodians are not non-profit organizations. Apart from their primary roles and responsibilities described in the previous section, there are several other housekeeping and other transactional or regulatory services that they offer; as a way of supplementing their internal revenue streams. These can include fund bookkeeping and accounting, regulatory, contractual and legal compliance management, taxation services, etc.  The primary functions of the mutual fund organization is the administration, operation and accounting. Remaining back office functions are frequently outsourced to custodians to streamline the fund’s own operations and also as a means of achieving cost efficiency.

Importance of the Mutual Fund Custodian

Apart from the different important roles played and responsibilities carried out by the mutual fund custodians, another significant aspect is the policing of the misuse of power and authority by any entity within the mutual fund organization. There are occurrences when a director or a fund manager may possess too much authority and access to the investor’s fund. Fund managers are directly involved in the investments being made and trades being conducted, while the custodian in ensuring detailed record keeping and regulating the flow of money involved in these transactions. With the division of roles between the fund managers and custodian, financial prudence is maintained and improprieties can be averted.

In Summation

To recap our learning from this blog, the mutual fund’s board is responsible for selecting the mutual fund custodian. This is usually in the form of a bank or a reputed bank or financial institution. The broad purpose served by the custodian of a mutual fund is to safeguard the investor’s assets while ensuring regulatory compliance to SEC and other guidelines. It also helps in policing the processes, ensuring detailed record keeping of all trades and transactions. This is done with the objective to minimise accidental errors and negate deliberate attempts at fraud. In addition to the aforementioned, a custodian may also engage in activities such as settlements or redemptions of units / shares, risk and compliance management, and tax services for its clients.