'We have scratched barely 25-30% of the surface'

The past year has been good for the mutual funds sector, with equity folios regaining the 40-million mark and assets under management at a record Rs 13 lakh crore. A panel of chief executives from seven leading fund houses that got together at the Business Standard Fund Cafe 2015 was confident the growth could be sustained and pitched for simpler know-your-customer norms to create an equity culture. In fact, they were unanimous that assets would grow to Rs 20 lakh crore in the next three years.

On the key enablers for the MF industry's growth

Sundeep Sikka: It's not just the assets that have increased to Rs 13 lakh crore; a lot of qualitative factors have improved as well. Retail investors are coming back after almost three years of negative flows in the industry. Last year, we saw almost 1.5 million new investor folios and 8 million systematic investment plan (SIP) folios being created and what is important is that the investors coming in from smaller cities and towns is increasing. The biggest success for the industry will be the kind of wealth it creates.

There are two big enablers that will help the industry achieve an assets under management (AUM) of Rs 20 lakh crore by 2018. First, every year the entire industry conducts more than 1,000 investor education programmes across cities and small towns of India. And we are seeing the benefit of that getting reflected. Second, there has been a lot of pitch from the government on how to increase financial savings. Money parked in real estate is coming into financial assets. With the push that we are seeing from the government and the support of the regulator, I believe that this industry is poised for very good growth.

Nilesh Shah: I would first like to explain why we should be able to get to Rs 20 lakh crore before 2018. Today, we are at Rs 13 lakh crore and let's assume the general average 10 per cent return. That would confine me to about Rs 70-80 crore by December 31, 2017. EPFO never invested in equity but now they have started. This year they will invest about Rs 5,000 crore. Next year, hopefully it will be Rs 10,000 crore and Rs 15,000 crore thereafter. So given the approval to EPFO, we should able to reach Rs 18 lakh crore by December 2017.

The reason why I am so bullish about the mutual fund industry is because we have about 10-15 million actual investors. If we see that vis-a-vis the number of people who file income returns, we would have barely scratched 25-30 per cent of the surface. If we compare that vis-a-vis people who should file their income tax return, we would have barely scratched 10-15 per cent of the surface. We have done a great job in reaching out to those 10-15 million investors but this could be 10 times more.

Until now real estate was giving great returns, gold was giving great returns. People were saying why should we invest in mutual funds? If I am not investing in mutual funds, I am okay. Now, investors have realised that real estate markets are correcting all over the country and in gold people have lost money. And they are realising that mutual funds - be it equity or fixed income funds - have actually delivered far better returns.

Leo Puri: I also think that the number to really focus on is not the headline number but the equity portion. In equity, where we are at Rs 8-9 lakh crore as of now. It is a good indicator of the health of the industry. Liquid funds and money market funds are also important but not as critical to the health of the industry.

On the polarisation in the market and money chasing fewer stocks

Milind Barve: There is a significantly higher premium for quality today. The long-term experience of investors has been that poor quality eventually gets punished. So I think that when we say that I am going to look at quality, people are willing to chase quality at PE multiples which are based on historical records and quite unrealistic. It is not just about quality, fund managers are looking to invest in companies that have the potential to develop into high-quality companies in the future. It is not simply a matter of running quant numbers but looking at the business model, management quality and the right growth ingredients for the company. So there is a tendency sometimes that you take the shelter of high-quality companies because they have very strong, stable earnings. But they probably don't add much value. There are companies sitting at 35 PE (price-to-earnings) multiples, 40 PE multiples and have gone on to become 60 PE multiples. Would you want to pay for them further up to 80 PE multiples? I don't have an answer to that.

A Balasubramanian: The markets have the tendency to run ahead of expectations, that's why we are seeing 60-80x PE multiples. Two years back we assumed that the worst is over for bank NPAs. But the worst has just continued. The commodity cycle of the last 10 years has been taken away in a matter of few months. Money managers have to prepare for such kind of eventualities. While we can't predict events, historically, our industry has done a great job of mitigating risks. And they manage assets in such a manner that diversification is taken care of.

Nimesh Shah: Quality at any price is working in the market. Another thing which is worrying is the mid-caps space. The PE ratio of mid-caps is higher than the large-caps. That is another area of concern. I think this industry has done well because we have a set of happy customers. Today it is important to set the expectations right. In a lot of products people have made 50-60 per cent return in the last year and a half, since October 2013. It is important to see how AMCs manage risks, manage expectations and create products that are less volatile. Though we can't do away with volatility, we can create asset allocation products to reduce volatility for the final customer. I think if this industry gives returns better than fixed deposits, customers will be very happy.

No matter how much we educate investors, psychologically, people are going to give us the maximum money when the markets are at an all-time high. Most of the industry's products are traditional products which will remain invested in equities whether markets are high or low. We need to increasingly look at a set of defensive products so that customers can have minimal negative experiences. The pain of losing Rs 5 is more than the joy of getting Rs 30.

Dinesh Khara: In such markets, expectations go up like anything. Typically, it is always the rear-view mirror kind of experience which people expect to see going forward as well. AMCs should engage with investors to showcase their track record and also tell them how things could change. The second area to look at is a fund's risk management capabilities. Sebi (the Securities and Exchange Board of India) is permitting a hedging mechanism which can help reduce risks.

On India being a bank-driven economy and capital-market related institutions not getting the attention they should

Leo Puri: Our markets, including the capital market, have developed ahead of institutions from the domestic perspective. This is why you have actually seen foreign institutions play a legitimate role in actually helping and developing these markets. That is evident when we look at our equity market; it is also increasingly evident when you look at our fixed income market and if you were to continue to relax in a way Indonesia has in sovereign bond limits, overnight you will find foreign institutions dominating our fixed income market as well. Institutions will come from any part of the world and it's fine. But I do think given the relatively early stage of development that India is in, it will be important for our policymakers to think about the anchor institutions that they want to develop domestically. Japan is a good example of a country which developed with a right balance between global institutions and local institutions. Those countries which are capital exporters naturally build strong domestic institutions because they have something to offer to the world. We have an opportunity to build both institutions and markets, and we must not lose that.

Milind Barve: An institution is really driven by what customers in that country want. You can draw a nice blueprint of how the institutional framework should operate. But at the end of the day you need customers to participate in the market. In India people first want preservation of capital and then want to look for an optimal return. That's why more than 55 per cent of households' savings go into bank deposits. And I am not arguing against it. But there is a growing number of people looking to ask questions to their financial advisors - what more I can do?

Nilesh Shah: The perception that India does not export capital is a myth. The data suggests that we had imported gold worth $280 billion in the past ten years. It does not include any smuggled gold as data is not available for that. It also does not include data about silver, diamond and pearl which we are importing. The total FII money we have received $160 billion dollar in equity and $80 billion in debt. That's $240 billion. So have we not exported $40 billion outside? But the perception is that we are importer of capital and not exporter of capital. For me 2008 was the best period because we got stocks so cheap back then. So while it was a bad year for some, others spotted the hidden opportunity.

On managing customers' expectations online

Nimesh Shah: For existing customers, it is very easy to transact online. The biggest challenge for the sector is how to get the customer enrolled. When you go to Flipkart, you do not have to fill up a form before you buy. We are working with the regulator on this. Somewhere we need to get our KYC (know your customer) simplified. I think the committee is working on if we can use the Aaadhar card somewhere to get the KYC done. Banks have huge number of customers. A very small percentage of customers are able to deal in mutual funds for various reasons. Most of our customers would have an Aaadhar card and we need to integrate it in the common KYC. Aaadhar card has already done the in-person verification, if we are able to simplify this one regulatory hurdle of KYC, I think this industry can grow in a huge way.

Khara: If we can accept bank KYC as valid for mutual funds, the reach could be phenomenal. We can get many more investors on board, especially the younger generation who are put off by paperwork. Simpler KYC will help create an equity culture in the country.

Is the industry responding to customer needs?

Sundeep Sikka: Over the last decade or so we saw the industry coming up with a lot of exotic products. But the majority of investor flows are coming in simple, vanilla products. This industry's key innovation - systematic investment plan (SIP) has been one of the primary reasons for investors getting a very pleasant experience as it addressed the biggest issue that the investors had - that of exiting in a falling but cheap market, reacting to short term newsflow, and so on. Thus, the industry has been responding well to customers' needs, but it is an evolving process.

On selling mutual funds becoming less attractive to distributors

Nilesh Shah: If a financial advisor is only a mutual fund distributor and if he does have significant size or scale it might not be lucrative for him to pursue this profession. Today's distributor has no option but to be a multi-product distributor (mutual funds, insurance, financing, etc) which will help him sustain operations. The issue is that investors don't value the advice given by the distributor. If there are 15 million customers and 15,000 complaints it should be seen in that context.

Nimesh Shah: Mutual Fund distribution is a volume, and not a margin-driven business. It is a myth that mutual fund distribution is not a profitable business. If you have a three-year horizon it is a fantastic business to be in.

On whether mutual funds should become more active in shareholder activism

Leo Puri: I think you will see us engage much more with companies, and most boards have welcomed this engagement. It is not about activism but simply taking a stand on behalf of investors to avoid the possibility of value destruction.

Khara: Governance issues can arise in some companies, especially in the mid-cap space. Considering the kind of exposure that funds have to various corporates, their say on management issues becomes critical.

On putting more skin in the game

Nilesh Shah: Our employees made a voluntary pledge to invest in Kotak MF schemes. This pledge has now been converted into a code of conduct.

Nimesh Shah: In our case, a part of the employee bonus is automatically invested in the schemes of the company and the employee gets it after three years.