The troubles of the mutual funds in India today – contrary to convenient and popular interpretations – are not simply the fallout of regulatory actions like the ban on entry load much to the chagrin of distributors, or of the low fund management fees and profitability of asset management companies. The causes lie much deeper. So, the woes are unlikely to abate quickly and easily by a mere rectification of past errors. In fact, the troubles of mutual funds are the cumulative results of the way in which mutual funds have been functioning for a long time.
There are a number of players in the mutual fund story — the fund managers, distributors, financial advisers, wealth management teams, registrars and other service providers and, of course, the investors. But central to the plot are the investors; the remaining players exist because of them and not the other way round. However, at different points of time in the past 10 years – especially when the stock market did well and the possibilities of a long and wantonly abundant spring always looked like a certainty – different sets of characters in the Indian mutual fund story have taken precedence over investors’ interests.
The Indian financial market, unlike the financial markets of developed economies, has some built-in distortions that are unlikely to go away. The data on the distribution of the annual gross financial saving of the household sector since the 1970s, obtained from the Reserve Bank of India Report of the Working Group on Savings during the 12th Five-Year Plan (2012-13 to 2016-17), show the continued dominant preference of the household sector for time deposits of commercial banks, life insurance products, small savings schemes and provident and pension funds, though the sectoral allocations varied from decade to decade (see chart 1).
The time deposit rates in India and their share in financial savings have traditionally been much higher than most developed economies. From the 1970s till the 1990s, the share was around 40 per cent and it increased to around 50 per cent between 2005 and 2011. Asset management companies in India need to be aware of this trend as well as of the major determinants of savings of Indian households and be sensitive to their underlying psychology while designing their products and targeting different market segments.
When a lay investor who has faith in time deposits is induced to invest some of his savings in mutual funds, he will remain satisfied so long as the market remains chirpy and his mutual funds give him returns far in excess of the time deposit rates of commercial banks. But a falling market and declining net asset value (NAV) is bad news for him. The words “in the long run the equity market provides the best returns” or “your fund has done better than the Nifty as it has declined less than the Nifty” may not give him much solace. Mutual funds are not risk-free investments and the lay investor is not told so when he is advised to invest.
This is a reality with which fund managers will have to contend. Measures such as enhancement of fund managers’ fees or increasing the commission to distributors or tinkering with the permissible fees for asset management companies will certainly make life easier for all of them and that is certainly necessary — after all, they are in a business and not doling out charity. But these actions may not be enough to draw investors to part with their nest eggs. So, it is desirable that mutual funds and the market temper their expectations from these measures. For fund managers, chasing the assets under management (AUM) is important, since the market share of a mutual fund and the key performance indicators of the fund manager are measured in terms of AUM. For investors, the returns are important, AUM growth hardly matters.
Sustained growth of a mutual fund depends on its ability to attract new money, which can come from either the influx of new investors or the existing investors investing additional money. There is a general belief that mutual funds are concentrated on a limited geographical area in the country, which makes a good case for mutual funds to reach out to investors in semi-urban and rural areas. But this would require asset management companies to build their own networks or lean on somebody else’s. Developing a distribution channel takes time and money and, so, the argument goes that increasing incentives to asset management companies will help them invest in the infrastructure to reach potential semi-urban and rural investors.
The important question to address here is whether asset management companies have explored and exhausted opportunities in metropolitan and urban areas. Data from the Association of Mutual Funds in India show that mutual funds have been able to gather 90 per cent of their subscription from 18 cities. In other words, in the past 20 years, mutual funds have not even fully exploited the potential in metropolitan cities. Time deposit growth in banks has been driven by metropolitan areas and urban centres and growth in aggregate deposits from these areas alone far exceeds the aggregate AUMs of mutual funds (see chart 2). Accessing the metropolitan and urban markets should perhaps be easier than semi-urban and rural markets.
A quick analysis of growth of mutual funds (see charts 3 and 4) gives interesting insights into the operations of mutual funds. It also raises several questions about the prevailing perceptions and myths generated in recent times.
- A steady growth of AUMs of mutual funds since 2004 till 2008.
- A sharp fall in 2009 and a rise in 2010 and 2011 to levels higher than the peak in 2008.
- Regulatory actions did not seem to have caused a permanent disability in mutual funds, as was made out to be.
- The decline of AUM and in the number of the folios, could have been the consequence of the market conditions and the disappearance of the froth and fizz, which resulted from the unwholesome churning that was permitted wantonly by mutual funds.
- Debt has a greater share of mutual fund assets than equity and growth of the AUM has been driven more by debt since the mid-2000. This is interesting given that fund managers get more basis-point advantages from equity schemes.
The securities market regulators, unlike governments and the central banks, have limitations in their ability to kick-start a segment of the market. Fiscal incentives may not always be the most dependable long-term crutch to lean on. Any other incentives can only be at the cost of investors. Hence these would need to be prudently balanced with long-term benefits to investors. But the impetus for growth would have to come from within the sector itself. In the circumstances, the long-term policy focus on mutual funds would necessarily have to be on the sustainable growth of the sector and on regulations that preserve an environment for innovation, encourage asset management companies to design new business models, develop differentiated products for different segments of investors and engineer processes to widen the reach of the mutual funds.
These views are personal. The author is a former executive director of Sebi and is currently associated with International Finance Corporation’s Global Corporate Governance Forum and the World Bank.
