Mutual funds' growing heft

Maintaining the confidence shown by investors is crucial, as a single bad episode could spoil the party

The crossing of the Rs 50 trillion mark in net assets under management (AUM) by mutual funds (MFs) in India in December is a remarkable feat. Undoubtedly, over time, MFs have emerged as the most important institutional investor in the Indian capital market.

To begin with, let’s consider some broad statistics. The AUM of the MF industry grew over six-fold during the last 10 years, increasing from Rs 8.25 trillion on March 31, 2014, to Rs 50.77 trillion on December 31, 2023. Over the same period, the total number of investors (unique PANs) in MFs has shown a five-fold increase, rising from 8.8 million to 42 million.

The current AUM of MFs as a proportion of total bank deposits has crossed 25 per cent, indicating the increasing clout of MFs in the country’s financial sector. If one looks at the growth trajectory of the equities market, the MFs and individual investors have emerged as important participants. As of September 2023, their holdings accounted for 8.7 per cent and 9.7 per cent, respectively, in the total market cap of listed companies. Though foreign portfolio investors (FPIs) continue to be significant market participants, with their holdings at 18.4 per cent, their proportion has come down over the period; it was over 22 per cent 10 years back. 

Of the total current AUM of MFs, 43 per cent is in equity schemes. Out of this, more than 90 per cent is owned by individual investors. The MF industry has been able to build and maintain the trust, with many investors preferring to enter the markets through them. In fact, MFs have played a pivotal role in the financialisation of domestic household savings in the country — nudging savers to become investors.

The increased ease of onboarding, including on account of e-KYC, and growth of digital platforms have helped expand the reach of MF to semi-urban and even rural areas. The regulatory framework has kept pace with the changing market conditions. The efforts made to bring in more transparency, such as disclosing the total expense ratio charged by the MFs, classifying MF schemes, benchmarking their performance, and improving the disclosure mechanism, are commendable. The ever-growing systematic investment plans (SIPs) in MFs have in a way democratised the investment culture. SIPs have become household names where one could invest as low as Rs 500 per month. The average monthly gross number of SIP accounts added during FY24 (up to December 2023) was 3.15 million, a significant increase from the 0.63 million recorded in FY17. The gross SIP flows during December 2023 reached an all-time high of Rs 17,600 crore.

Notably, the investment culture in the country got a big leg-up during the post-Covid period, starting from 2020-21 onwards. There has been a spike in the number of new demat accounts and enrolments in the MF schemes. The prolonged low interest rates on bank deposits during 2020-22 pushed even the risk averse individuals to explore the capital market. As far as the MF industry is concerned, there couldn’t have been a better example of “Aapda Mein Avsar” (opportunity in crisis). Luckily, the Indian capital markets have performed rather well since 2020, thereby keeping the investors’ faith intact. The growing investment culture has also been a wake-up call for banks, used to taking the depositors for granted. Consequently, banks, previously viewing CASA (current account savings account) deposit inflows as their divine right, have become more responsive to market signals, periodically revising their deposit rates.

What has not been fully appreciated is the fact that the MF industry growth has had many positive externalities in improving the overall market structure and culture. Some of them are narrated below.

MFs have played a crucial role in deepening the Indian corporate bond market. They are the only domestic institutional investors willing to venture into the relatively low-rated debt securities. Not only that, they shine as the only bright spot in the hitherto moribund secondary market trading activities. The debt market crisis of 2018 and 2020, which was largely on account of an underdeveloped corporate bond market, impacted the credibility of debt mutual funds. The good part is that the lessons learnt were not wasted. The market regulator was quick in strengthening the regulatory oversight in consultation with and active participation from the MF industry. The salient changes included — an improved methodology for the valuation of debt securities, the setting up of a limited purpose clearing corporation for corporate bond repos, and the establishment of a backstop facility for corporate debt securities. Notably, a substantial 26 per cent of the total current MF AUM is in debt securities. While it could be argued that the steps taken by MFs were in their own interests, there is no doubt that these measures would go a long way in improving the robustness of the bond market in India.

FPI investments in the Indian capital market play a major role in providing liquidity and depth. However, much of this investment is also hot money, and the sudden capital outflows can have a debilitating impact on the market while also weakening the Indian currency. The increased market participation by MFs and individual investors in the last few years has, to an extent, provided a counter-balancing mechanism and helped stabilise the market.

MFs have gradually increased their efforts in meeting stewardship responsibilities towards their investors by enhancing engagement with investee companies and monitoring their performance. Though the market regulator had, more than a decade ago, mandated MFs to disclose their voting rights policies, the prescription in 2021 making the voting on corporate resolutions compulsory has nudged MFs to play a more proactive shareholder role. Other institutional investors could learn from them.

Looking ahead, there is tremendous scope for the growth of the MF industry in the country. Even after accounting for the recent surge in MF inflows, the current MF AUM/gross domestic product ratio in India is only about 18 per cent. In comparison, this ratio is 21 per cent in China, 75 per cent in the UK, and 149 per cent in the US. More efforts are needed to make this product attractive beyond the top 30 cities. “Mutual fund sahi hai” campaign has been successful. The MFs and the Association of Mutual Funds in India (Amfi) should continue to meaningfully utilise the mandated two basis points of the AUM for investor education. The most important aspect is to keep intact the investors’ faith in the system. This is a huge responsibility on the MF industry — they have to maintain discipline and be candid on disclosures. A single bad episode could be enough to spoil the party.

The growth in MFs in India is a success story, and credit must be given to the MF industry, Amfi, and Securities and Exchange Board of India. Amfi has set ambitious projections for Rs 100 trillion in MFs’ AUM and 100 million investors by 2030. All the very best to them.

The writer is a former chairman of Sebi