 "Dip in inflows not a concern: Leo Puri")
Despite the decline in net inflows, fund houses cite the success of systematic investment plans (SIPs) and the rising investments in debt schemes to indicate a secular trend of traction in mutual funds. While the heads of five leading fund houses agreed that technology will play a key role in the future, most believe it would facilitate rather than replace humans. Edited excerpts from the Business Standard Fund Cafe held in August at Mumbai:
On improving trust and the credibility factor
Leo Puri: We should first take some comfort from the fact that significant strides have been made in terms of the sales process, product and pricing alignment, transparency and disclosures. The right structure for an asset manager is to be independent. But I do want to emphasise that at some point we will have to address the issue of corporate ownership and governance structure in the industry in the way that we have addressed them for banks.
Lower quality debt papers and risk management
Milind Barve: Over the last so many years there is a lot of focus on stepping up disclosures and improving transparency. Also, the fact that we are judged on performance very closely by investors. So an ecosystem has developed where we are known as much for the way in which we conduct our business than just the numbers that we deliver. It is incumbent on any asset manager to have a robust risk management process in place because risk management is now a fiduciary responsibility. It’s not a matter of choice. So, governance, trust, all these things get demonstrated by how you manage your risk and how honest you are with your customers and all other stakeholders.
D P Singh: We have robust risk mitigation processes in place internally. But we have to walk the talk. Ultimately, the outsider has to consider you trustworthy. We have to be trustworthy because we are the custodians of people's wealth. This is an on-going process. Today, more and more people are entering investing through mutual funds.
Sharp fall in inflows in the first half of 2016
Nilesh Shah: The tendency of the normal investor, which is the first segment of investors, is to book profits when returns are as high as they have been. The second segment, which is retail-oriented, is probably putting in Rs 3,000 crore in SIPs every month. The third segment of investors is the high net worth investor (HNI) segment which is keeping faith and is probably shifting from one fund to another fund but remains invested in equities. So I am not too worried about the flows. If there is a correction in the market we will actually see more flows coming into pure equity funds. This time we will not see people running away because markets have corrected.
Leo Puri: Our business is never linear. It should not be linear because you will have asset allocation shifts occurring as well. Some of this is an asset allocation process towards debt and balanced funds, which is very healthy and rational. You have different segments operating in the markets such as pension funds and long-term investors who will keep investing steadily. You will have HNIs which will time the market because they believe they are sophisticated investors. I am not concerned by a temporary drop in equity flows. In fact, I will be a bit surprised if that did not happen because we are not in a linear market.
Equities still small as compared to other asset classes
D P Singh: We are not worried about the flow of money coming into equity funds. We have to look at the complete picture. Flows in the fund industry are increasing, whether it is in equity funds, hybrid funds or debt funds. When we talk about education, we have to talk about not only equity, but also tax laws, tax efficiencies and bringing in more people and technology.
Nilesh Shah: Competing with other financial products is on a non-level playing field, given high distributor margins (in segments such as gold coins, jewellery) and lax know your customer details. If we see vis-à-vis insurance, clearly there is non-level playing field there also in terms of distribution. We have our constraints and within that we deliver what we believe is fantastic performance. Hopefully, one day there will be one common level playing field across financial products.
Concerns regarding cap on commissions
Nilesh Shah: We will have to compensate the decrease in margins by volume expansion. How do I reach from 10 million customers to the potential of 250 million customers? At this current cost structure I will not be able to reach and this is not the best way to reach out to them. Can I use technology? Can I use means to equip my distributors so that they focus more on selling and not service? Hopefully, that will be a win-win situation for the customer, the distributor and the manufacturer.
The issue of high expense ratios
Nilesh Shah: Empirical evidence shows that the mutual fund industry is competitive. You have to look at what we actually charge and not what the caps are. There are many products where we are not actually operating at the maximum level, for instance, in debt funds and balanced funds. It is an important issue that gets neglected.
Exchange traded funds, passive products and index funds are also driving costs down.
Milind Barve: It is not right to conclude that total expense ratios (TERs) are necessarily high. The net asset value is computed after including this. And if funds are performing and generating 5-6 percentage point outperformance consistently year after year in spite of the so called high TER, then the TER needs to be judged differently. On under-penetration of our products; micro finance institutions are lending at high rates because there is a recognition that if you want to reach a certain level of society that needs to be financially included and if that product has to be accessed there is a cost to it.
Incentives for B15 towns
Sundeep Sikka: My personal view is that it should be abolished. It should be made available, that is, the extra incentive should be given across the country for investors who invest less than Rs 2 lakh. The idea is to get retail investors. Why should a guy who is investing Rs 1 crore in Nashik be treated as a lay investor while someone in Dharavi who is investing Rs 100 be treated as very educated? The way to approach this is to have to segmentation not based on geography but on categories of investors. Anything that adds to cost will be questioned by investors at one point of time.
Leo Puri: The purpose of B15 was to ensure that there was a viable and sustainable economic incentive for the creation and growth of distribution structure. The 4-4.5 million customer base is nothing; we should be at 40-45 million. Intermediation is the first step to climb on the ladder and it is not happening through technology. I am strongly in favour of incentivising people and distributors in smaller towns.
Role of technology and challenges for mutual funds
Nilesh Shah: Technology can create disruption, taking over jobs of fund managers and distributors and the way we do business. But we need to understand that India is a heterogeneous market. There’s one section of the society that is taking to technology faster than the rest. Even in the US, they are finding it difficult to shut branches as customers continue to walk into branches. So we must adopt technology that can help us reduce costs and expand business. We need to adapt to technology sensibly.
Milind Barve: There is a lot of talk about artificial intelligence. But investment is still an art and not a science. It is a personal skill. While technology can play a big role, investment management is very much to do with skill of an individual. We still need the fund managers, artificial intelligence cannot take over that role.
Leo Puri: I think differently. Nobody thought that a chess algorithm could beat a Grand Master, but that has happened. It has happened in the game of Go, medical diagnosis and healthcare. So I think it’s just a matter of time how you use research and computing in this industry. Of course there is an element of art to it. I see it happening in the next two-five years; it’s clearly not some 10-20 years away to see this happen.
Sundeep Sikka: Mutual funds require human nudge to push people to invest in them. Offline and online will continue. The distributor will use technology which will enable him to service more clients. Technology will help in reducing operating costs. Robot advisory will be there, but it cannot replace the financial advisor.
Leo Puri: There will always be an appetite for people to choose to go to people for advice. Their ability to deliver superior outcome is what I am questioning. But behavioural science is different from computational science. But I believe you will not find any difference in the quality of outcome between the two as information asymmetry is reducing. Because India is a market with deeper information asymmetry than many other markets is why you see the alpha persisting. It’s not something which we need to fear, we need to welcome it as it would allow our industry to grow more.
D P Singh: The challenge for the distributor is to acquire clients. So if he can be helped by a machine to reach more clients, then we are adding value to him. We need to use technology to reach to more people than substitute fund managers.
Nilesh Shah: There will be someone to disrupt our industry like how Alipay disrupted the banking industry. It’s better we disrupt ourselves.
Sundeep Sikka: There is a need for technology. In what parts and what stages is what is being discussed. But I don’t think technology will disrupt us. It will help us.
Need for simplifying products
Nilesh Shah: There needs to be a level playing field within funds. It can’t be that one fund having 80 per cent allocation to equity in balanced fund, when another fund is different. The regulator is not creating a level playing field this way. The law has to apply universally and not differently as someone got approval at a different time. Second is consolidation of schemes. One fund house has five large-cap schemes, and another has only one. If it has to be simplified, simplify at one go. Clearly there is need for consolidation and common allocation of schemes. The regulator cannot have one set of funds running a normal race and another running a hurdle race. We need sophistication of products, we are a heterogeneous country and products have to be tailor-made.
The role of exchange traded funds
Sundeep Sikka: Over a longer period of time, low expense ETFs will be the rule of the game. ETFs have grown in a big way and it is time for it to catch up in India. But different investors have different liking for different products. We need to offer those options for financial planners and investors to choose. With regulatory push coming for advisory, ETFs will become a bigger product. It would evolve faster than machines becoming fund managers.
Leo Puri: Passive investing is different from machines replacing humans. There’s a problem with having ETFs dominating mutual funds — it will become a self-fulfilling thing. This is dangerous for the vitality of the economy. So active management will have a strong role to play in addition to ETFs. Without active management there will be no asset allocation methodology left in the economy. Why should I be forced to allocate capital to a company simply because it is part of the index? It’s dangerous to the very idea of capitalism.
Milind Barve: The real question to ask here is who are the investors? Investors decide what they want to invest in. Geographies where passive funds are growing, investors are mostly institutional and not retail. They are long-term pension investors, who prefer low cost passive investment style. The people who are choosing passive funds are different, like retirement and pension funds. In India, we do not have meaningful participation of this segment. Low cost active management will be the winning formula.
On improving trust and the credibility factor
Leo Puri: We should first take some comfort from the fact that significant strides have been made in terms of the sales process, product and pricing alignment, transparency and disclosures. The right structure for an asset manager is to be independent. But I do want to emphasise that at some point we will have to address the issue of corporate ownership and governance structure in the industry in the way that we have addressed them for banks.
Lower quality debt papers and risk management
Milind Barve: Over the last so many years there is a lot of focus on stepping up disclosures and improving transparency. Also, the fact that we are judged on performance very closely by investors. So an ecosystem has developed where we are known as much for the way in which we conduct our business than just the numbers that we deliver. It is incumbent on any asset manager to have a robust risk management process in place because risk management is now a fiduciary responsibility. It’s not a matter of choice. So, governance, trust, all these things get demonstrated by how you manage your risk and how honest you are with your customers and all other stakeholders.
D P Singh: We have robust risk mitigation processes in place internally. But we have to walk the talk. Ultimately, the outsider has to consider you trustworthy. We have to be trustworthy because we are the custodians of people's wealth. This is an on-going process. Today, more and more people are entering investing through mutual funds.
Sharp fall in inflows in the first half of 2016
Nilesh Shah: The tendency of the normal investor, which is the first segment of investors, is to book profits when returns are as high as they have been. The second segment, which is retail-oriented, is probably putting in Rs 3,000 crore in SIPs every month. The third segment of investors is the high net worth investor (HNI) segment which is keeping faith and is probably shifting from one fund to another fund but remains invested in equities. So I am not too worried about the flows. If there is a correction in the market we will actually see more flows coming into pure equity funds. This time we will not see people running away because markets have corrected.
Leo Puri: Our business is never linear. It should not be linear because you will have asset allocation shifts occurring as well. Some of this is an asset allocation process towards debt and balanced funds, which is very healthy and rational. You have different segments operating in the markets such as pension funds and long-term investors who will keep investing steadily. You will have HNIs which will time the market because they believe they are sophisticated investors. I am not concerned by a temporary drop in equity flows. In fact, I will be a bit surprised if that did not happen because we are not in a linear market.
Equities still small as compared to other asset classes
D P Singh: We are not worried about the flow of money coming into equity funds. We have to look at the complete picture. Flows in the fund industry are increasing, whether it is in equity funds, hybrid funds or debt funds. When we talk about education, we have to talk about not only equity, but also tax laws, tax efficiencies and bringing in more people and technology.
Nilesh Shah: Competing with other financial products is on a non-level playing field, given high distributor margins (in segments such as gold coins, jewellery) and lax know your customer details. If we see vis-à-vis insurance, clearly there is non-level playing field there also in terms of distribution. We have our constraints and within that we deliver what we believe is fantastic performance. Hopefully, one day there will be one common level playing field across financial products.
Concerns regarding cap on commissions
Nilesh Shah: We will have to compensate the decrease in margins by volume expansion. How do I reach from 10 million customers to the potential of 250 million customers? At this current cost structure I will not be able to reach and this is not the best way to reach out to them. Can I use technology? Can I use means to equip my distributors so that they focus more on selling and not service? Hopefully, that will be a win-win situation for the customer, the distributor and the manufacturer.
The issue of high expense ratios
Nilesh Shah: Empirical evidence shows that the mutual fund industry is competitive. You have to look at what we actually charge and not what the caps are. There are many products where we are not actually operating at the maximum level, for instance, in debt funds and balanced funds. It is an important issue that gets neglected.
Exchange traded funds, passive products and index funds are also driving costs down.
Milind Barve: It is not right to conclude that total expense ratios (TERs) are necessarily high. The net asset value is computed after including this. And if funds are performing and generating 5-6 percentage point outperformance consistently year after year in spite of the so called high TER, then the TER needs to be judged differently. On under-penetration of our products; micro finance institutions are lending at high rates because there is a recognition that if you want to reach a certain level of society that needs to be financially included and if that product has to be accessed there is a cost to it.
Incentives for B15 towns
Sundeep Sikka: My personal view is that it should be abolished. It should be made available, that is, the extra incentive should be given across the country for investors who invest less than Rs 2 lakh. The idea is to get retail investors. Why should a guy who is investing Rs 1 crore in Nashik be treated as a lay investor while someone in Dharavi who is investing Rs 100 be treated as very educated? The way to approach this is to have to segmentation not based on geography but on categories of investors. Anything that adds to cost will be questioned by investors at one point of time.
Leo Puri: The purpose of B15 was to ensure that there was a viable and sustainable economic incentive for the creation and growth of distribution structure. The 4-4.5 million customer base is nothing; we should be at 40-45 million. Intermediation is the first step to climb on the ladder and it is not happening through technology. I am strongly in favour of incentivising people and distributors in smaller towns.
Role of technology and challenges for mutual funds
Nilesh Shah: Technology can create disruption, taking over jobs of fund managers and distributors and the way we do business. But we need to understand that India is a heterogeneous market. There’s one section of the society that is taking to technology faster than the rest. Even in the US, they are finding it difficult to shut branches as customers continue to walk into branches. So we must adopt technology that can help us reduce costs and expand business. We need to adapt to technology sensibly.
Milind Barve: There is a lot of talk about artificial intelligence. But investment is still an art and not a science. It is a personal skill. While technology can play a big role, investment management is very much to do with skill of an individual. We still need the fund managers, artificial intelligence cannot take over that role.
Leo Puri: I think differently. Nobody thought that a chess algorithm could beat a Grand Master, but that has happened. It has happened in the game of Go, medical diagnosis and healthcare. So I think it’s just a matter of time how you use research and computing in this industry. Of course there is an element of art to it. I see it happening in the next two-five years; it’s clearly not some 10-20 years away to see this happen.
Sundeep Sikka: Mutual funds require human nudge to push people to invest in them. Offline and online will continue. The distributor will use technology which will enable him to service more clients. Technology will help in reducing operating costs. Robot advisory will be there, but it cannot replace the financial advisor.
Leo Puri: There will always be an appetite for people to choose to go to people for advice. Their ability to deliver superior outcome is what I am questioning. But behavioural science is different from computational science. But I believe you will not find any difference in the quality of outcome between the two as information asymmetry is reducing. Because India is a market with deeper information asymmetry than many other markets is why you see the alpha persisting. It’s not something which we need to fear, we need to welcome it as it would allow our industry to grow more.
D P Singh: The challenge for the distributor is to acquire clients. So if he can be helped by a machine to reach more clients, then we are adding value to him. We need to use technology to reach to more people than substitute fund managers.
Nilesh Shah: There will be someone to disrupt our industry like how Alipay disrupted the banking industry. It’s better we disrupt ourselves.
Sundeep Sikka: There is a need for technology. In what parts and what stages is what is being discussed. But I don’t think technology will disrupt us. It will help us.
Need for simplifying products
Nilesh Shah: There needs to be a level playing field within funds. It can’t be that one fund having 80 per cent allocation to equity in balanced fund, when another fund is different. The regulator is not creating a level playing field this way. The law has to apply universally and not differently as someone got approval at a different time. Second is consolidation of schemes. One fund house has five large-cap schemes, and another has only one. If it has to be simplified, simplify at one go. Clearly there is need for consolidation and common allocation of schemes. The regulator cannot have one set of funds running a normal race and another running a hurdle race. We need sophistication of products, we are a heterogeneous country and products have to be tailor-made.
The role of exchange traded funds
Sundeep Sikka: Over a longer period of time, low expense ETFs will be the rule of the game. ETFs have grown in a big way and it is time for it to catch up in India. But different investors have different liking for different products. We need to offer those options for financial planners and investors to choose. With regulatory push coming for advisory, ETFs will become a bigger product. It would evolve faster than machines becoming fund managers.
Leo Puri: Passive investing is different from machines replacing humans. There’s a problem with having ETFs dominating mutual funds — it will become a self-fulfilling thing. This is dangerous for the vitality of the economy. So active management will have a strong role to play in addition to ETFs. Without active management there will be no asset allocation methodology left in the economy. Why should I be forced to allocate capital to a company simply because it is part of the index? It’s dangerous to the very idea of capitalism.
Milind Barve: The real question to ask here is who are the investors? Investors decide what they want to invest in. Geographies where passive funds are growing, investors are mostly institutional and not retail. They are long-term pension investors, who prefer low cost passive investment style. The people who are choosing passive funds are different, like retirement and pension funds. In India, we do not have meaningful participation of this segment. Low cost active management will be the winning formula.