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Trend Watch : How Big is Big

The Indian mutual fund industry has been growing, but is still not big enough to make its presence felt. What stops it from taking the giant leap?

The Smart Investor Team

They manage assets worth $6.7 trillion (Rs 308 lakh crore) and more than 8,000-odd schemes. And almost every second household owns some of them. No, we're not discussing Indian mutual funds - we are talking about the US mutual fund industry, the most powerful force in the US investment landscape.

Indian mutual funds would love to be in this league. Unfortunately, they are a long way off. Indian fund managers continue to wait for that "inflexion point" that's supposed to bring about a dramatic change in their fortunes.

American inves-tors, meanwhile, continue to look upon mutual funds indulgently - despite the industry hitting a rough patch after the dotcom bust of 2000. US investors still swear by the riches bestowed upon them by their mutual fund industry in the last decade - this despite the phenomenal losses some investors have made in the post-dotcom era.

The 1990s were a spectacular decade for American mutual funds: investors simply couldn't seem to get enough of them. Starting out in 1990 with $1.1 trillion in assets, American mutual funds ended the decade with over $7 trillion in assets under management. Even the number of funds on the menu tripled from 3,000-odd to 8,000 by the end of 2000. Over half of them are equity funds

Those heady numbers are prompting questions about whether India's fledgling mutual fund industry can ever hope to achieve that kind of triumph. On June 30, 2003, Indian mutual funds commanded assets of Rs 1,04,762 crore, 8 per cent of the retail deposits of scheduled commercial banks. In the US, mutual funds overtook bank deposits some years ago.

To be sure, private funds grew from nothing to Rs 77,591 crore in the decade (1993-2003) after private funds were allowed to be floated. During the period, UTI's assets dropped from Rs 51,709 crore in 1993-94 to less than Rs 30,000 crore at the end of June 2003. The corpus of public sector funds also fell significantly during the period.

The domestic fund industry has only peddled faster to remain where it was many years ago. Though most fund professional would dispute this, arguing that the investor base has changed, the fact remains that the investor base has not really expanded.

This is a critical difference. The bulk of investors in private funds today are not really those who switched from public sector funds. On the contrary, it is the corporate investors that are using funds as a strategic tool in their treasury operations. Retail investors, the type who should ideally be looking at mutual funds with a long term investment objective, are simply nowhere in the picture.

However, no one's complaining. The industry has been in existence for under a decade and most fund managers believe it is still early days for it. While we've had one mutual fund - the UTI - for over three and a half decades, private and foreign fund houses were only allowed to operate in India from 1993.

Today, about 36 fund houses - private, state and foreign-owned - operate in the country, but the the Indian mutual fund industry's pace of growth can hardly be described as frenetic. In all fairness, however, there are reasons for that.

S Naganath, joint president and chief investment officer, DSP Merill Lynch Investment Managers, believes that even in the western world, the realisation that there was big money to be made in mutual funds only sank in during the 1990s. One reason, he says, is: "Since 1992, the American equity markets have seen a secular bull run, and this has created an equity cult." Even the bond markets got a tremendous boost from lower interest rates, he adds, hinting that the allure spread to investors with a wide spectrum of risk appetite.

The evidence supports that: between 1990-2000, the Dow Jones Industrial Average (DJIA), the oldest and most well-known US stock benchmark, jumped from a little over 2,500 to 10,000 levels. On an average, the Dow added about 15 per cent every year. The meltdown in the equity markets after that has definitely meant that the value of equity funds has eroded. Even so, equity funds account for 44 per cent of the total assets American mutual funds manage.

Another important reason has been the emergence of the "401(k)" (pension) market. As Americans began to pay attention to their own retirement plans through company-sponsored retirement schemes, called "401(k)" plans, mutual funds started being looked upon as a smart option. Says Prakash Dalal, chief marketing officer, Kotak Mahindra Mutual Fund: "The introduction of a 401(k) type plan can make the demestic mutual fund industry really leapfrog."

Other elements also played a part in revving up the economic environment - and in casting mutual funds in a favourable light. For one, emerging markets slowly started coming into their own, pushing the world to the realisation that there were financial markets worth investing in other than their own local markets. With the idea of overseas investing gaining rapid currency, mutual funds latched on, taking with them scores of enthusiastic investors.

"Mutual funds allowed investors a convenient way to take an exposure to these markets," points out Naganath. Customer offerings also turned more sophisticated, as financial markets invented more products: securitisation sprung up, as did asset-backed mortgages. Voracious mutual funds were only too eager to pounce on them as potential money-making opportunities.

Indeed, US mutual funds today come in all forms: their investment choices are not limited to just stocks, bonds and money market instruments; they extend to physical assets such as gold, real estate, and even commodities..

No such luck

Unfortunately, we haven't had the coming together of a similar set of favourable conditions in India. In fact, the see-sawing stock markets have given equity funds here a bad name. A rash of scams, frequent political bickering and economic uncertainties have conspired to keep the Sensex, the nation's most widely tracked index, at around the 3000-level, approximately the same level it was in 1993.

Overall, Indian investors have had a poor experience with public sector mutual funds, which till recently managed the bulk of retail mutual fund money. The failure of funds to honour their promises in assured return schemes was the first big blow.

"Owing to the hangover of underperforming mutual funds, particularly the public sector ones, investors were apathetic to mutual funds in general" says Sameer Kamdar, national head, mutual funds, Mata Securities, the largest distributor of mutual funds in the country that focusses on institutional clients.

But just when investors tried to test the waters once again at the height of the tech-driven euphoria, the meltdown in the markets, and therefore in technology funds, spoilt their party again.

Today, the net asset values of most tech funds are only a third of their par value. Investors have little hope of getting back the initial capital.

It's understandable, then, why retail investors treat equities - and equity funds - with disdain. Less than two per cent of Indian households own equity assets. Even fewer own equity mutual funds. "The entire situation in respect of the volatility we have seen in equity markets has created a belief among retail investors that mutual funds are bad," says Ved Prakash Chaturvedi, chief executive officer, Tata TDW Mutual Fund. And it is not just equities, there is a problem on the debt side too.

It's a typical trait - and one that has been often talked about. Indians - like many Asians - are still unwilling to experiment with investment vehicles that don't assure them of fixed returns. That's why, even in this high-tech, information-at-your-fingertips-age, a lot of Indians still channel their savings into bank deposits and old-style investments in gold bars and jewellery.

And then, higher yields on alternative debt products, especially the government's small saving schemes, have kept individual investors from giving mutual funds any serious thought. "The relatively high level of assured returns (in small savings schemes) is one of the most important reasons for investor indifference to mutual funds," says Krishnamoorthy Vijayan, chief executive officer, JM Mutual Fund.

N K Sharma, chief executive officer, IL&FS Mutual Fund, agrees: "The existence of alternative investment options which provide assured returns from sovereign class securities made a debt fund look comparatively unattractive."

Currently, the public provident fund assures a return of 8 per cent. Popular small savings schemes such as National Savings Certificates, National Savings Scheme and Kisan Vikas Patra yield the same returns. For marginal tax payers, these instruments form the core of their investment portfolio. There is little inclination on their part to risk their capital in mutual funds given that their experience with tax planning (equity linked savings schemes) funds like the UTI's Master Equity Plans, Canbank Mutual's Canpeps, and others launched in the early and mid 1990s has been bad.

Most of these funds have returned less than the 12 per cent assured return on alternate instruments even at the end of their full 10-year tenure.

However, the recent performance of debt funds is creating some amount of pull. Says Chaturvedi: "A large number of investors have made a lot of money in debt funds in the last three years and some of them have turned into die-hard fans of the mutual fund industry today."

Still, as of now, only big business houses and companies have warmed up to the idea. This group of investors' money accounts for over 70 per cent of the local mutual fund industry's assets. And if despite the phenomenal success of debt funds retail investors are not coming in droves, the fund industry needs to do some serious introspection.

Most retail investors have backed away from mutual funds primarily because they don't understand the product. Says IL&FS MF's Sharma: "The institutional investor understands mutual funds and the benefits of investing through mutual funds. However, the retail investor is still evolving in the financial planning space. Once the retail investor has grasped the full scope of a mutual fund, the penetration jump will be almost instant."

Whose fault?

Till now, the lack of understanding has been a key obstacle in pumping up growth. Even the army of agents and brokers pushing mutual fund units in street corner shops aren't of much help; in fact, they're quite ineffective. Often they're just ordinary salespersons, unaware themselves of the finer points of mutual funds.

Without competent advice, it is all too easy for first-time investors to make the wrong choices. And one mistake may be all that is needed to make investors recoil from investing in mutual funds forever. Obviously, much of dissatisfaction among fund investors can be blamed on the mis-selling and the greed of mutual fund companies.

Often, the best time to sell a mutual fund is not the best time to invest and vice versa, agree most fund professionals. "However, to survive, mutual funds have to sell the flavour of the day," says another fund manager who does not wish to be identified. The ills of this opportunistic selling can be curbed only if there are educated professionals selling the product, which is not the case in India.

"It is only in recent times that the industry has invested in retail distribution and has seen serious distribution houses coming into the fray. Physical infrastructure in the fund industry is weak compared to banking infrastructure," says Chaturvedi. Banks have got aggressive in fund distribution only in the last two years.

Besides, it is only of late that banks have got over the fear of losing customers to mutual funds. "On the contrary, banks have realised that they make more money by way of fee-based income by selling mutual funds" says Deepak Mungla, head of sales, Alliance capital. All this does augur well.

Yet ground level issues persist. For instance, the public sector banks which are well entrenched in the country do not have the right kind of people to advise investors about funds. Says Mungla: "Most public sectors banks are not well equipped to sell mutual funds." Besides, dealing in mutual funds is not as simple as investors would like. Says Kotak's Dalal: "The transaction convenience associated with mutual funds is not very high."

All this is a far cry from what happens in the US markets. There, qualified financial advisors recommend what funds and other assets you should be investing in, after studying your financial position and goals.

In India, a growing chorus of opinion wants Indian fund marketers to equip themselves with the same kind of expertise and qualifications while recommending fund units and other financial assets. The regulatory authorities have finally paid heed to these voices - mandatory certification of financial planners and mutual fund agents has been introduced - it has taken time to yield results.

After all, fund companies are not running a charitable business. The sponsors want to see profits too. Indeed, because it's so difficult to break down the barriers of retail investor suspicion that, as many sales managers reluctantly acknowledge, funds find it far more rewarding to zero in on corporate clients.

With the lower transaction costs involved in dealing with large sums of corporate money, it is not surprising that the Indian fund industry isn't too perturbed about the lack of retail interest.. Says R Subramanium, of Enam Financial Consultants: "The cost of client acquisition is prohibitively high for mutual funds to focus their efforts on retail customers. After all, they have to earn a decent return on their capital." The rapid pace of consolidation in the industry is only a manifestation of this.

Yet market sources say that the race to enhance asset size is actually spoiling the market. "The mutual fund market has become extremely institutionalised," says Mata Securities' Kamdar. Read between the lines: big companies are actually gaining at the expense of distributors, fund companies and retail investors. Distributors are forced to pass on more commissions to companies, while fund companies are compelled to offer funds with wafer thin margins. Retail investors lose out in the sense that they continue to pay higher expenses.

Specially designed products for corporate investors like the Fixed Maturity Plans charge less than 0.5 per cent to the fund. The regular debt funds which are available for most retail investors still charge between 1-1.5 per cent. Some late entrants like Duetsche Bank Mutual Fund are actually working at near zero expenses to gather assets.

Some fund professionals do agree that mutual funds should redefine their role. "Fund companies should actually be focus on fund management rather than treasury operations" says Sanjay Sachdev, chief executive officer, IDBI Pricipal Mutual Fund. "Most fund companies are compromising on medium and long term money while chasing short term goals" he adds. That's theory. Says Chaturvedi, "The incremental benefit of investing in retail infrastructure outside the top 10 cities is a challenge to justify. The only way to look at it is that in the long term, it makes sense."

Hope survives

So can mutual funds make it big in India? The potential certainly exists. The numbers speak for themselves: the world's second-largest population comprising over one billion people, and a propensity to save that is considered one of the highest in the Asian region, outside of Japan. Savings are equivalent to about 22 per cent of India's GDP.

Yet, not everyone is pulling out the welcome mat for mutual funds, although a growing band of converts is starting to consider it a truly worthwhile investment option. Statistics show that nearly half of all Americans own shares or invest in equity mutual funds. In contrast, Indian equities - and equity funds - haven't acquired the power to captivate a significant swathe of investors yet.

No doubt, it will take time for the Indian fund industry to come of age. Things are improving though. While retail investors continue to show a dull appetite, fund marketers are only hoping that other ingredients will help in powering growth in Indian funds. As in the case of the US industry, the answer may ultimately lie with the financial markets. "For a sustained growth in the Indian asset base, we need a secular bull market," DSP's Naganath notes.

And the time may be just ripe for that to happen. The Indian economy, in transition for over a decade, has introduced some deep-seated changes in the way Indians do business. Indian industry has struggled to work off its excesses.

But after painful but much-needed bouts of shedding excess staff and costs, Indian business is slowly picking itself off the floor.

All these efforts will have a salutary effect on future profits. This should help stocks acquire more allure; the hope is that some of it will rub off on equity funds as well. "When stock market are good, mutual funds fly in formation" says J Rajagopal, managing director, Bluechip Corporate Investment Centre, a retail mutual fund distributor.

So if stock market do oblige, mutual funds can make it big.



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