The mutual fund industry will be unhappy that the finance ministry has finally rejected its demand that it be included in the Rajiv Gandhi Equity Savings Scheme announced in this year’s Budget, a demand that the market regulator had puzzlingly chosen to support. Under the scheme, first-time investors can claim a tax break on 50 per cent of an investment of Rs50,000 in direct equity. The industry argued that direct equity for first-time investors may not be advisable and that a three-year lock-in could be detrimental to them. And, if a first-time investor in equity loses money, she may never return. This argument is not without merit. However, it is perhaps more true that mutual funds believed they needed some regulatory hand-holding after previous clampdowns – such as the ban on “entry load” charges in 2009 – were crucial causes of assets under management taking a hard knock, or so they try to claim. It is true that incremental flows into bank deposits, mutual funds and insurance have slowed sharply over the last one year — bad news for capital-starved India. However, inflation is the primary reason for the overall decline in the savings rate from 37 per cent in 2008 to 32 per cent of gross domestic product last financial year. The stated reason for the entry-load ban was that distributors were making investors churn their portfolios to earn commissions. Similarly, with little incentive to sell, distributors stopped selling mutual fund schemes.
But does the mutual fund industry really deserve or need preferential treatment (like inclusion under the Rajiv Gandhi scheme) just because it is temporarily troubled? For one, distribution is only one of its many ailments. Yes, if products have to be sold, distributors have to be incentivised; but the industry cannot blame its current condition entirely on the entry-load ban. The Indian mutual fund industry has too many schemes, and the regulator has been pushing companies to consolidate them. A poor-quality product, no matter how well marketed, cannot succeed. The dismal performance of mutual funds also means that they have minimal pull factor on investors. Securities and Exchange Board of India (Sebi) Chairman U K Sinha recently raised the red flag by pointing out that there are nine fund houses where 50-100 per cent of in-house schemes have underperformed their benchmark indices. Last year’s Standard & Poor’s Index-versus-Active Funds scorecard (produced in partnership with Crisil) showed that a majority of actively managed Indian mutual funds had underperformed their respective benchmarks over a period of five years. The performance has been no better over a three-year or one-year period.
While the mis-selling of funds by distributors can be resolved through a system of clawback rules – wherein if a distributor is seen to “churn”, his future commissions are impacted – regulation alone cannot make the industry deliver. Just as for distributors, there’s no such thing as a free lunch for asset management companies. It’s time they did something about their performance instead of hoping for government help.