BS Fund Manager: Can mutual funds win back the confidence of investors?

Given the recent credit events and equity market volatility, the going may not be easy for fund houses

A Bengaluru-based investor decides to retire early at the age of 53 years. He decides to invest a part of his retirement kitty in a low-duration fund to earn a percentage point more than the bank fixed deposit (FD). On June 4, he gets a rude shock. The fund’s net asset value (NAV) erodes 6 per cent in a single day, which is nearly equal to the annual return delivered by the category in the past one year. According to mutual fund (MF) advisors, investors who have gone through such shocks because of some of the recent credit events are unlikely to come back to debt funds.

For several investors exposed to schemes holding debt papers of Dewan Housing Finance Corporation (DHFL), the hit was much worse. There were cases where schemes with higher exposure to DHFL had to bear a hit of 30-50 per cent on their NAV.

Investors’ interest to debt products stemmed from the prospects of slightly better returns than FDs and higher tax-efficiency. However, lack of understanding of inherent risks in a debt scheme has caught many investors off-guard. Industry experts say that several investors are now reversing their allocations from debt products, back to bank FDs.

According to industry participants, it would take a while before investor confidence can be rebuilt.

“Getting more investors into debt schemes will take time. Credit events have been a first-time shock for many investors. Also, understanding of debt products is much worse than equity products. For instance, people still don’t understand duration-related risks, understanding of credit risks can take longer time,” said Radhika Gupta, chief executive officer of Edelweiss Mutual Fund.

Radhika Gupta, CEO Edelweiss MF

 

Industry participants add that there are investors who don’t understand the basic concept that a borrower paying a higher yield (interest rate) is riskier than a borrower giving a lower yield. “On the equity side, investors understand that a small-cap company is riskier than a mid-cap company, but a similar understanding of risks is not seen on the debt side. So, a lot of efforts will be needed to educate the investors,” Gupta said.

Running into trouble

The concerns over debt schemes emerged in September last year after the IL&FS group’s default. The liquidity crunch in debt markets led to higher yields for non-banking financial companies (NBFCs), where MFs were among the major investors. 

As the yields inched up to price-in the increased risks, the price of debt papers issued by NBFCs started to come off; leading to mark-to-market hit on debt schemes. The bulk of the stress was in the shorter-term debt market, where NBFCs had participated heavily due to availability of cheaper funding.

During this troubled period, build-up of stress in other corporate houses such as Essel and the Anil Ambani group also tempered return expectations of debt investors.

Finally, when the liquidity tightness in the system caught up with the widely-held DHFL on June 4 and it defaulted on its debentures, over 160 MF schemes were affected. Overall, the MF industry’s exposure to the stressed corporate groups has been in the range of Rs 20,000 crore.

Ray of hope

While debt schemes have had their fair share of setbacks, equity schemes have also failed to live up to investor expectations due to spike in market volatility. 

In the one-year period, the NAV of large-cap schemes has declined (indicating negative returns) by an average 6 per cent, while the decline for mid- and small-cap schemes has been 14 per cent and 18 per cent, respectively. As a result, investor flows in both these segments have come under pressure. 

Even as flows have stayed positive on the equity side, the average monthly flows were 34 per cent lower at Rs 9,322 crore in 2018-2019. 

In debt schemes (excluding liquid schemes), the net investor outflows have been more than Rs 68,000 crore — starting from September last year till March 2019. Liquid schemes, which are institutional focused-products, have seen more than Rs 1.8 trillion of outflows in the same period.

The road bumps in both these segments have slowed down the pace of growth of the mutual fund (MF) industry. At the end of 2017-2018, the industry’s asset base stood at Rs 21 trillion, which was 21 per cent higher than previous year. The industry closed 2018-2019 with assets of Rs 24 trillion, growing at 11 per cent or about half of the previous year’s growth rate.  From betting on debt schemes to drive its next leg of growth, the industry is now hoping equity schemes to take lead in restoring the higher trajectory of growth.

“Despite volatility in equity markets in the past one year, the monthly net sales (inflows) in equity segment has been Rs 7,000-8,000 crore, which is a healthy sign. The positive way to look at this is that the industry is still able to incrementally bring in new investors to the asset class even though growth has tapered,” said Kalpen Parekh, president of DSP Investment Managers.

Kalpen Parekh, President, DSP Investment Manager

Industry participants, however, are also hoping that stock markets will see some recovery so that investor sentiment stays afloat. This will help in holding up the equity flows.

Fears of global recession amid the ongoing trade tensions between the US and China has taken a toll on markets. Also, forecasts of a slower economic growth on domestic front have contributed to investor nervousness and the broad-based sell-off. On September 3, benchmark indices cracked over 2 per cent, clocking their worst single-day fall since October 2018.

Industry players add equity flows could lose the recent momentum if markets remain under pressure as MF investors tend to chase trailing returns. As highlighted above, equity schemes have delivered negative returns in recent times.

Keeping check

The concerns on the debt side have prompted securities market regulator, the Securities and Exchange Board of India (Sebi), to introduce a slew of changes to improve the risk-management practices in the industry.

MF industry players believe that over time these changes will help in reviving investors’ confidence. 

“The prompt action taken by the regulator to review and refine various debt-related regulations can be a source of comfort for the investors. It demonstrates the MF industry’s willingness in improving investor experience and transparency,” said Vishal Kapoor, chief executive officer of IDFC Mutual Fund.

According to participants, due to a high level of transparency and regulations governing the industry, MF products are likely to remain the first-choice for investors as and when sentiment begins to improve. 

In the past, the Sebi has also taken various measures to simplify equity schemes which led to consolidation of funds with similar investing styles/objectives within a fund house, changing definition of large, mid and small cap stocks, etc. “Other investment products like unit-linked insurance plans lag behind MFs on these parameters,” said a fund manager, requesting anonymity.

Potential for growth

According to industry insiders, the change in sentiment can quickly shift the growth trajectory of the industry given the sharp under-penetration.

“India ranked seventh in terms of nominal gross domestic product (GDP), yet in terms of MF assets under management (AUM) India ranks 17th. In a country of 1.3 billion people, less than 2 per cent invest in MFs; whereas in developed economies like the US this figure is much higher,” pointed out N S Venkatesh, chief executive of the Association of Mutual Funds in India (AMFI), in the vision document for industry’s Rs 100-trillion asset mark.

In the case of India, the AUM to GDP ratio stands at 11 per cent, which is much lower than penetration in other developing countries such as Brazil (59 per cent) and South Africa (49 per cent). Also, the rise of systematic investment plans (SIPs) has given a cushion to the industry’s cyclicality. Over the past three years, SIPs’ contribution to the industry has compounded at an annual growth rate of 45.3 per cent. In 2018-2019, SIP contribution stood at over Rs 90,000 crore, with the monthly contribution averaging at Rs 7,182 crore.

Caution ahead

But, apart from the efforts that the industry will have to take to restore investor confidence, it will also need to boost its reach. Deepening the penetration of India’s MF industry would also need a wider distribution network, which can hand-hold investors in tier-II and tier-III cities. In the top 15 cities, there are 4,300 AMFI registered numbers (unique code allotted to intermediaries ) for every million households. However, the ratio falls sharply to 230 in beyond the top 15 cities.

According to industry participants, adequately incentivising independent financial advisors (IFAs) will be key to ensure this category of intermediaries continues to grow. “If MFs continue to pass on majority of cuts in fee structure to IFAs and other distributors, these intermediaries could switch to other investment products and that could impact the industry’s future growth,” said a distributor, requesting anonymity.