'Growth will come from smaller cities'

For almost two years, the Indian mutual fund industry has been reeling under the pressure of declining assets under management and number of folios, especially in the equity segment. On top of that, the weak market sentiment has only added to its woes. Against this backdrop, six chief executive officers of leading fund houses participated in the Business Standard Mutual Fund Round Table. The topic: Way forward for the mutual fund industry. The Round Table was moderated by Shyamal Majumdar. Excerpts:

MODERATOR: It is exactly two years since the entry load ban was imposed. As a CEO, how difficult has it been? How have business models been impacted?

Naval Bir Kumar (NBK): The fund industry did feel the impact in 2008-2009. But if you look at the flows, they tend to increase when you are in the midst of a bull market. It is obviously an incorrect method of investing, but that is the nature of investors. And it’s a trend we have seen for many years. So it is hard to say whether it was the bad market conditions or the changes in entry load regulations that impacted growth. Investors tend to come into the markets when markets tend to get expensive. The bigger challenge that we, in the mutual fund industry, face today is to change the psychology of the investor. In India, you have very limited retirement savings and there is an under-penetration of the insurance sector. So the bulk of the savings of the Indian population tends to be discretionary. I think we have to break some of these mind sets and trends. I think the fund industry is challenged due to lack of financial literacy and trying to inculcate better investments habits.

Sandesh Kirkire (SK): I will take a cue from what he said. I think it is all boiling down to financial literacy. I don’t think we are more financially illiterate than the rest of the world, but the rest of the world has done something different. That is, they force people to look at long-term savings. Hence, the rest of the world has a large retirement savings available to the markets. Coming to the current state of the mutual fund industry, the entry load withdrawal is something the distributors/agents are getting used to in the past six months to a year. If you do an analysis prior to the entry load withdrawal, you will realise that the industry was not really adding to the assets. Coming to mutual fund industry per se, I would say 45 per cent to 50 per cent of the total assets are distributor-based. The issue is how are we going to bring back the longevity of an asset. I think in the last two years, the industry has taken a focussed approach towards systematic investment plans. That seems to be working well. The question is how do we enhance penetration in these top 80 or 100 cities. There is no option for an investor other than to look at mutual funds, if he wants to create a long-term asset. I am reasonably bullish on the future of this industry purely when I look at the potential.

MODERATOR: That brings me to the point that there is a need to inculcate better industry literacy. Do you think the industry has done enough to improve the awareness about mutual funds as a product?

Harshendu Bindal (HB): I think, both yes and no. I think financial literacy needs to be increased on an overall basis, not just for the mutual fund industry. The government and the private financial services players need to get involved. Your pension plans and insurance plans encourage people to put money into capital markets. And when people see the benefit of that, it will be one way of financial literacy. I think the industry per se has been doing its bit. We have these investor awareness programmes that we are doing.

MODERATOR: The opinion is that there is a need to do a lot more. Could you tell us two or three specific points that you have done to create awareness of mutual funds because everybody keeps on talking about it?

Sundeep Sikka (SS): We need to understand whether it is financial literacy or education, there are a billion people in India. And only one per cent of the country is investing in mutual funds. There are two big issues which we need to understand, one is the awareness and the other one is understanding mutual funds. At this point of time, both the awareness as well as the understanding of mutual funds is very low. The good thing is almost all stake holders in the industry, whether it is AMFI, Sebi or MCA, everybody is doing a lot of road shows. But ultimately, the beauty of mutual funds is such that investors cannot stay out of them for a very long time.

Nimesh Shah (NS): Distributors need to be educated about the overall benefits of mutual funds. I will divide the instruments in three parts. Money market, debt and equity. To educate them that it is good for your business to distribute money market funds. First, they should take to money market, then, switch over after a period of time into equity. Actually, the quality of distributors that are left in the industry are also the ones who are advisors. Debt funds can be a challenge in the next six months, but it is relatively easier to convince a person to come into money market funds.

SK: It should be a total solution for the customer from the point of view of asset allocation, which includes money market funds, debt, equity, MIP and also gold. The mutual fund industry has not grown to the extent that one would like it to grow. Every distributor has to accept the fact that you need to be lot more passionate about the solution rather than just asset class product. That is one. The average equity asset is about 30 per cent. The rest is coming from debt funds that always provide an opportunity when the interest rates are high. The stage will come where income funds will become attractive. There exists an opportunity in income oriented funds, which would include the monthly income schemes and equity which always do well in the longer term. In the short-term, investors are bound to shy away. The best time to advice is when there is uncertainty in the immediate future.

MODERATOR: How do you respond to the criticism that the industry has made things too complicated, in the sense of having thousands of schemes with many options?

NS: First of all, I wonder from where these thousands of schemes come from. Options have come because the investors wanted it. Somebody wanted dividend, others don’t. Obviously every scheme, then, will have that kind of options.

But I agree with you that there was a phase between 2004 and 2007, when there were a lot of NFO’s. But one thing is very clear, with the changes that have happened, money comes only into schemes which have a very good track record. The only way to grow your equity funds is that if you have done a good job for the final investor and given him decent returns. How good you are in sales will not matter as much as your scheme’s performance.

Since the last one year, SEBI is actually encouraging mutual funds to combine schemes which are not required. So a lot of mutual funds houses have done that, in terms of the combining schemes and this will continue in the next few years. Even from the perspective of distribution, it is not possible to distribute so many products at the same time.

MODERATOR: One of the natural consequences of this entry load ban was supposed to be the emergence of financial advisors. Even agents were supposed to graduate to become advisors. But it is being said that the mutual fund industry is paying brokerages from their own pocket to distributors, who in turn, are passing it to the investors. In that sense, the industry has itself to blame for not allowing the emergence of financial advisors.

SS: Ultimately every AMC will have to make his own business case and decide what they have to pay. But if you have to go back to the 2009 entry load ban, it was said (for the first time) that advisory will be priced. What that means is that the distributor or the financial advisor will sit down with the investor, give him the financial advice, and based on that, investors will decide on the pricing. In a country like India, where advice is always given free, it is taking some time for distributors for getting that fee. And that is a reality.

But it is just a matter of time. As the financial sector evolves, advisory will become more and more important. I will just give you a very interesting number. Over the last 10 years, if you were to look at the top five schemes in the industry, they have given an average return of 28 per cent compounded annual growth rate (CAGR) whereas the bottom five have given a return of 13 per cent – a difference of 15 per cent CAGR. When the investor becomes aware of what does this advice means, how he is benefiting from it, he will not find it difficult to pay 1-2 per cent as financial advisory fee.

SK: The difference between this business and any other business is the cost that the customer pays here is a regulated cost. If you are buying a consumer durable today from a distributor, if you are getting something from the manufacturer but you are not aware for the cost that you are paying, or the cost that is going in creating that consumer durable. All that you know is the selling price. Mutual funds, in that sense, are so very different. Customers know exactly how much they are going to pay when he invests in a fund, a manufacturer knows exactly how much he can charge a customer.

For every 100 rupees that is created in the market 80 rupees is derivatives, 20 rupees is cash. Less than 5 rupees is for delivery. Equity markets have been in existence for over a century. Mutual funds regulations came in 1996. Today, equity investors who access equity markets through mutual funds are more in number than those who have direct access to equity markets. The total number of demat accounts in the country stands at 16 million. If you remove the duplication, you don’t have more than 5 million active investors in the Indian equity markets. You have about 40 million folios in the Indian equity markets. If you remove duplication, the number of unique investors would be 5 million as well. And the latter has been in existence for just the last 15 years. So it is not that the industry has not done enough, there are various other host of issues. Earlier, we had an administered regime, where investors were paid assured kind of returns. So it takes a really long time for them to really understand how to create wealth over the long term. But rest assured, it is in our interests to get long-term money and more investors.

NVK: We live in an industry where sales are through an indirect channel and hence, the customer is owned by the distributor. From an investor’s perspective, he is totally protected today. The cost that the investor pays is fixed and irrespective of what the fund manager may pay to the distributor, it does not impact the investors’ returns.There are individual business models that fund managers may evolve. But at the end of the day, the regulator ensures that the investor is protected. There is a cap on all costs and is very transparent. The schemes also have a high level of transparency, in terms of disclosure of funds portfolios and NAVs on a daily basis. There are enough web sites that do analysis of fund returns etc.

But at the end of the day, you have a situation where the advisory plays a much bigger role, because he deals with an investor who is less aware, and because he owns the investor he has a stronger bargaining role with the fund manager. But at some point of time, that equation will become equal as investors tend to become far more financially aware, ask the right questions and if they are not happy with the distribution model start buying into fund products directly. That model that in the western world will put the challenge back to the distributor and make the playing field far more level. It is a process. I think investing in India has just started. It is a nascent industry.

People didn’t have to invest, people used to get fabulous returns seven-eight years back because assured returns schemes of the GOI paid you fabulous returns. In today’s market conditions, where capital markets are providing you with great returns, the mindset of the investor has to be changed. In the last 10 years, the industry has pulled in many more investors into the capital market than traditional products have done in the past. It is a process. I think it will happen.

MODERATOR: The regulator is pushing for more and more disclosures. Even if we put the entry loan ban aside, how tough has the regulator been?

AB: It is not the trend prevailing only in India, it is a trend which has emerged in most of the global markets and everywhere the regulators have become far more tougher when it comes to the question of compliance. The other area, which has also been challenging is predicting the regulatory changes. They are becoming the order of the day.

Internationally, the scenario is same everywhere. The regulations are, of course, far more tighter for the manufacturer. But it also needs to get implemented at the distributor level, who are actually the advisors to the clients on a day-to-day basis. This again means that they need to be a lot more diligent when it comes to advising the clients. What are the needs of the customer and then, advising them adequately. As a result, the service provider also needs to have a better compliance mechanism and a better packing mechanism, in the long-term interest of the investors.

SS: Today we are one of the most regulated industries. We are a very young industry, just 15 years old. There are changes happening. But we should not see every change from the regulator as something wrong. Higher disclosure and a lot of things will keep evolving. And somehow I get this feeling that this is not only true for our industry but also for a lot of other industries. There is nothing wrong in disclosures. Today, the mutual fund industry discloses more than any other industry. And even if more disclosures are required, I think it is more than welcome, as long as it is for the growth of the industry. Yes, it does add to the compliance cost but if you have to build something from a long-term point of view, these costs are inevitable. Today, total assets of the mutual fund industry are Rs 7 lakh crore. And I don’t see any reason why this industry will not be Rs 20 lakh crore over the next four-five years. Even it take more than five years, it really does not matter. Today, it is very important to have a very robust risk management and compliance systems. So, even if the cost increases, I believe it is good for the long-term interest of the industry.

HB: I think ultimately everybody is working for the growth of the industry. I don’t think that any change from the regulator should be construed as harsh. But too much has happened too fast. The good thing is that over the past two or two and a half years, the industry has realigned to the changes. And I think we are in the right direction now. Sometimes, there is too much change happening too quickly and the results do not having the impact that it should have. So I think whenever the changes are to be brought about, especially those which lead to far reaching changes in the business model, they need to be brought about in an orderly manner. There needs to be some discussion around it and time should be given to implement those changes. So when finally the regulation is out, it has the desired impact. I think when you have too many changes too quickly and nobody is assessing the impact, then you don’t get the desired result. I think that is the one aspect which needs to be looked at. Everybody feels that the change is positive and the trend is positive, but I also think that changes put a lot of pressures on the firms and for the players to adapt and I think that is something that needs to be looked at.

MODERATOR: Could you give us an example.

HB: Any change. I mean if there is a change wherby you need to do the business differently, I, as a player, need to understand the full impact of it. That is, how does it affect my taxation, how does it impact my operations, how does it impact my front office, how does it impact my back office, how does it impact the way I do business with distributors, what do I inform the clients and so on. There are a lot of systems that go into running a mutual fund company. A simple change may require software changes at our end, which are complex. So, there are these kind of things that need to be addressed in advance. Changes cannot be switched on suddenly. There are lots of other things that need to be considered in such situations, especially when you are in an environment where there are multiple regulations. The change that is brought about by one regulator may impact another regulator’s area and you may have to go to another regulator and ask them how to implement this. All these thing take a lot of time. Of course, these kind of things do happen when there are regulatory changes.

And I think that is why if you see in the western world, any change is brought in very slowly. It is brought after taking all views into consideration. And then the change is implemented. Once it is implemented, in very rare cases, it is changed again. In India, sometimes there are changes and changes to changes in a few months. That does not happen in a more settled environment. And I think things need to be evolved.

It is more to do with the speed of changes that you want to introduce. Clearly, whether it is the cost to the customer or the transparency for the customer, speed of implementation is something which will go a long way as far as the industry is concerned. But I would prefer a more consultative process, a long term discussion process with the industry and perhaps some timelines given to the industry to implement it.

MODERATOR: Recently, Sebi changed the entry load guidelines to incorporate costs of Rs 100 for investment beyond Rs 10,000 and Rs 150 for new investors. However, there already seems to be a demand from distributors that this amount is insufficient. Many are seeking a variable load etc. How do you see mutual funds, will it really improve things for you?

AB: It can always be debated whether the amount is sufficient, whether larger ticket size can be charged more and so on. But I would only assume that it is in the direction of increasing the participation of distributors, and investors. The other innovative thought, which has come as part of the regulation that anyone who comes in with a PAN card can open an account, will actually to expand the market and help increase the participation of the number of investors in the mutual funds industry.

It is in some sense getting better than the no-load regime. In some sense, from the distributors point of view it makes the job a little easy. I will only assume that it is in the right direction. And it can always be debated whether it is fixed or variable. But it is in the right direction and get people to start thinking, especially the small distributors. It may not be a great incentive in urban cities. But it will help people who are building up their business models mainly in deeper parts of the country. For them, it will help.

SS: I think we are really excited about this. We see this Rs 100 helping growth in smaller cities and towns. This could also help bring back investors to the mutual fund industry. I just thought that since we are talking of challenges, this is an opportunity that we should not miss out on. Bala was modest in saying it is a baby step, I will say it is a great step. Specially, for small investors, to come back to the mutual fund industry.