Sebi’s decision to abolish entry loads has given mutual funds a chance to relook their model which hasn’t caught the fancy of retail investors in a big way.
In the olden days (by that I mean the early 1990’s) when the financial markets in India were preserving their pristine purity, and life in such markets was simple, conventional wisdom was that mutual funds were the appropriate investment vehicles suitable for the small investors. But then times changed. Our markets became modern. The word ‘small’ was replaced by ‘retail’. It was, therefore, very interesting to note that Association of Mutual Funds in India (AMFI) that claims ‘developing the Indian Mutual Fund Industry on professional, healthy and ethical lines and to enhance and maintain standards in all areas with a view to protecting and promoting interests of mutual funds and their unit holders’ as one its lofty goals, still faintly echoes the remnants of the yesteryears when it describes in its web site ‘…thus a Mutual Fund is the most suitable investment for the common man…’ This calls for an ‘Aha’, because the data which the same web site has tells us a different story.
The table shows that that as of March 31, 2009, liquid and money market schemes, equity and debt-oriented schemes account for 95 per cent of the Assets Under Management (AUM) of all the mutual funds. Corporate, banks and financial institutions, and High Net-Worth Individuals (HNIs) accounted for nearly 80 per cent of AUMs, retail accounted for around 20 per cent of AUMs. In the liquid and money market funds and in the debt-oriented funds, companies and banks and financial institutions accounted for more than 80 per cent of the AUMs. The number of such investors is much less, and it is always more economical to service them. So logic would dictate that the fund houses would be more diligent and attentive to the 80 per cent group than to the 20 per cent group. But where does that leave AMFI’s ‘common man’?
The proliferation of the folios has another story to tell. The folios are not even a remote substitute for the exact number of investors, because of duplication. The portfolio numbers swelled in the last two years because of the multiplicity in the number of new schemes. The logic for floating more and more new open-ended schemes was simple and not a great work of innovative financing. Retail investors were advised by the distributors (their agents) that there was no point in entering an open-ended mutual fund scheme when the Net Asset Value (NAV) was more than Rs 10. She would be better off waiting till the next scheme was launched. The fund house was advised that it was relatively easy to sell a new scheme, rather than induce retail investors to buy existing schemes. So one fund house or another launched a new scheme at regular intervals, each semantically different from the old one. For example, a scheme could be named ‘Strong opportunities fund’ and the other could be called ‘Elevated and strong opportunities fund’ and one would be a fool to not choose something which was at once strong and elevated. This churning of funds did not matter to the distributors or the fund houses because both were digging into the entry load charged by the funds to the investors. In other words, it was the retail investor who was paying the distributor as well as the fund.
| Distribution of Assets Under Management by Mutual Funds | ||
| (Rs cr) | No. of Folios | |
| Liquid/Money market | 90,059 | 171,565 |
| Debt-oriented | 197,453 | 28,11,097 |
| Equity-oriented | 109,513 | 4,17,04,428 |
| TOTAL | 397,024 | 4,46,87,090 |
| All Schemes total | 418,765 | 4,75,98,163 |
| In Liquid, Equity and debt schemes | 95% | 94% |
| Retail share | 79,756 (20%) | 4,35,94,402(98%) |
| Corporate share | 207,384(52%) | 527,892(1%) |
| Banks/FIs share | 19,074(5%) | 8,066(1%) |
| HNIs share | 86,082(22%) | 556,597(1%) |
| (Source: AMFI’s web site; all data as of March 31, 2009) | ||
For example, in 2005, new equity schemes (NFOs) brought in an inflow of Rs 25,225 crore, while the existing schemes had a redemption of Rs 3,274 crore. Similarly, in 2006, NFOs brought in Rs 36,741 crore while the existing schemes lost around Rs 3,100 crore, taking the net inflow figure to Rs 33,665 crore. In 2007, new schemes inflows were at Rs 29,287 crore while the net inflows were far lower at Rs 21,071 crore. Thus it was the equity NFOs which were bringing in the funds, rather than the inflows into the existing open-ended schemes. More NFOs meant more business for the distributors. It also accounts for the proliferation in the portfolios in the equity-oriented schemes for the retail segment (see table). No wonder everyone but the retail investor was happy. Does that mean that the equity schemes did not do well? Of course they did well, but often not because of the astuteness of the fund managers, but more because of the market in general.
The fundamental purpose of regulation is not to prevent fools but to prevent people from being made fools of. This is where Sebi stepped in, by first abolishing entry loads for all mutual fund schemes; empowering the investors in deciding the commission paid to distributors in accordance with the level of service received and then ensuring that there was parity among all classes of unit holders in terms of charging exit load — that no distinction be made among unit holders should be made on the basis of the amount of subscription while charging exit loads. Besides, there would have to be full disclosures about payment of commissions. All that Sebi did was to bring the focus back on the ‘investor’ — the same ‘common man’ which AMFI refers to in its web site. But surprisingly, it created such an upheaval. Loss of cozy arrangements generally evokes such extreme reactions such as whining.
But Sebi has given the mutual funds an opportunity for a game change and the strategy would lie in using this as an opportunity and breaking existing markets and creating new ones. The Charles Schwab Corporation showed the way when it adopted a disruptive innovation model to take advantage of US Securities and Exchange Commission’s deregulation of brokerage fees on the Wall Street and became the largest discount brokerages in the world.
RBI’s latest Report on Currency and Finance says that the net financial savings of the household sector in 2008-09 were 10.9 per cent of GDP, lower than 11.5 per cent in 2007-08 and the household investment in shares and debentures fell to Rs 19,349 crore from Rs 89,134 crore. As a percentage of GDP, it fell to 0.4 per cent from 1.9 per cent. This is great market which the mutual funds in India have not taken advantage of. They can and have to learn to innovate and usher in a ‘retail revolution’ in mutual funds, instead of whining away over the loss of cosy and lazy way of making money. To do this, fund houses will have to revitalise their business model, use technology and reach outside the familiar markets. They must understand why the investors are comfortable with fixed deposits, post office schemes, NSCs, KVPs, LICs, precious metals and property in the second- and third- tiered cities and rural areas. They have to tap these markets, integrate innovation into the mainstream of their business strategy, and manage risks and create new markets and customers. Whoever said that becoming a leader in sustainable innovation was easy? But anyone who has the will to do so will surely find fortune at the bottom of the pyramid.
(The author is associated with the IFC’s Global Corporate Governance Forum and the World Bank; he was formerly the Executive Director of Sebi. Views expressed are personal. pratipkar21@gmail.com)
