What next for India's MF industry?

While the mutual fund (MF) industry has made great progress in India, it is undeniable that an overwhelming majority of our population is still excluded from the industry. This is largely because the focus of the industry has been on offering investment products to a largely savings-oriented population. As a result of this industry predilection with serving investors, most Indians continue to rely predominantly on banks to provide savings options.
 
As things stand, the MF industry in India caters to a tiny minority of the population which has achieved its basic financial needs. These basic financial needs go beyond the ability to manage regular expenses in a sustainable manner and includes savings that an overwhelming majority keep aside for emergencies and unforeseen circumstances. For these savers, the safety of their money and the ease with which they can access it in times of need are paramount. Returns come at a distant, and mostly irrelevant, third place.
 
A significant aspect of the industry’s success till date has been its ability to change the behaviour of retail investors to suit the products that it offers. Product innovation has been largely focused on serving the needs of institutional investors, with fixedmaturity plans being a prime example of this. While the benefits of this innovation did percolate to ultra-high networth individual investors as well, the majority to which it is eminently suited remains excluded.
 
The minority that the MF industry does serve has achieved a level of financial security and can take some risks with their investible surplus. Their goal is to ensure that this surplus grows at the highest possible rate. They prioritise returns and are often tolerant to risk and lower liquidity. Most MF products and services are designed to serve this minority and make their investment experience pleasant and sustainable. However, this minority only grows at a fast pace when the economy expands at a reasonable rate and doesn’t grow when it doesn’t. To break away from this link with the economic and market cycle, it is essential that the industry tries to expand its market and relevance.

One clear example of the beneficial effects of such expansion is a service implementation that that has become the bedrock of the MF industry in recent years: Systematic investment plans (SIPs).
 
In its early days, the SIP concept was promoted by the industry as a lower risk and disciplined approach to investing in equities for existing investors who were concerned about volatility. However, one of the primary reasons for its success is that it served not only those who had achieved a reasonable level of financial security, it expanded the market by including those at the cusp of it. The ability of the latter to access the equity markets by putting small amounts of money at risk and growing their exposure steadily was unparalleled in its innovation and the potential it unlocked. The resulting one-time increase in the number of potential investors meant that the industry grew at a very fast pace in recent years. However, the benefits of this increase are now tapering off and it is only a matter of time before investor numbers revert to becoming a function of national economic performance. Unless the industry grows its audience again.
 
Investors accessing the financial markets, either equity or debt, face a certain amount of complexity. For intermediaries to earn their keep, they can either reduce this complexity or increase efficiency by enhancing returns. Most products offered by the MF industry choose the latter route while savers have shown a marked preference for the former. Traditionally, banks have fulfilled this need by using their balance sheets to eliminate market risk  and provide fixed returns for their depositors.
 
Faced with the coming plateau and the danger of remaining restricted to a niche, the industry needs to innovate for the risk-focused, liquidity-preferring, return-agnostic masses. Products designed to include even a fraction of this majority have the capacity to increase the industry’s investor base manifold. The design and implementation of such products will necessarily need a multi-faceted understanding of regulations, underlying markets and investor behaviour. These products will need to be structured at the lowest possible cost to remain relevant. And since there is clear evidence that even existing low-cost products haven’t been effectively distributed through the existing distribution infrastructure, these will need to be accompanied by service implementations that ease access.
 
This is a complex task but not one that is beyond the capability of the industry and certainly not one that isn’t worthwhile. The Rs 117 trillion fixed deposit market that these products can disrupt is more than four times the size of the MF industry.
 
The question for the industry is not whether it is up to the task, but whether it can afford to not be.
 
The author is an economist and former CEO of Essel Mutual Fund