Saturday, December 19, 2009

Tectonic shifts in the mutual fund industry

The regulator is tightening the manner in which the mutual fund industry is being run. In August 2009, the Securities & Exchange Board of India (Sebi) ordered that the entry load charged by the industry be removed and that distributors charge commission directly to investors. And there are many other regulations in the offing that would tighten the operations further. But then these changes have come with an intention. A senior Sebi official told FE that this was part of a plan to get more retail investors under the regulatory fold. And this is clearly because, over the years, the fund industry has been concentrating heavily on the corporate sector or institutional investors, and therefore retail investors have been rather neglected. The effort to reach out and even educate them, had taken a back seat.

India’s mutual fund industry has a unique distinction of having being dominated by institutional investors. These investors contribute to around 56% of total assets under management (AUM), according to a study carried out by an independent research agency Celent. This compares starkly with the US, where less than 15% of the AUM is routed through institutions. And even in China, institutional participation is lower—at around 30% of the AUM. The skew in India is mainly due to tax advantages offered for mutual fund investment, and the lack of alternative short-term investment opportunities for Indian corporations, the Celent study revealed.

Even in India, the retail investor segment contributes to around 45% of the AUM, while the high networth individual sub-segment accounts for more than half, which is around 23%. High networth individuals have access to wealth management services and are likely to adopt the advisory model. For the remaining 20% of small-ticket retail investment, the transaction model is better because advisory services do not find traction in this sub-segment, according to experts.

Fund houses, therefore, would have to take a close look at building up the non-metro base. Mutual funds are skewed towards the urban segment. The top eight cities, including the four metros (Mumbai, Delhi, Kolkata, and Chennai) followed by Bangalore, Hyderabad, Pune and Ahmedabad contribute 75% of the assets collected, while the share of the next 20 cities was only 20%.

And this skew has also been impacting profitability. So while the AUM has grown at a compounded rate of 25% since 2006, the profitability, as measured by total income as a percentage of AUM, has fallen. The profitability on-average in 2008, was 16.5 basis points. This is a drop of 27% in profitability since 2006, which was 23 basis points, says the Celent study. “This drop is primarily due to the growth in the income funds—a direct consequence of corporations becoming the primary target for the mutual funds,” the report says.

To consider a case, Reliance Mutual Fund has a lower-income as a percentage of AUM, mainly because of the composition of its funds—-a heavy dominance of institutional investments in its asset composition has led to short-term funds dominating its portfolio, resulting in the suppression in the fee. On the other hand, ICICI Prudential has been able to garner better retail participation, and this is reflected in the higher fees that it charges.

The writing on the wall is therefore clear. Fund houses will have to concentrate on building their retail portfolios and also take funds to all corners of the country. Merely concentrating on the corporate segment might not work in the days ahead, as the regulator gets stricter on commissions and also on the manner in which funds are structured to attract corporate investments.

Sebi chairman CB Bhave has consistently been emphasising the need for asset management companies to focus more on the retail segment. The regulator has not forgotten the fright witnessed during the previous year when the corporate houses led a pullout from the mutual funds sector as a liquidity crisis emerged.

Some fund houses have been working on this aspect and would be working with non-traditional distribution channels like non-government organisations (NGOs) to build distribution strength. Such initiatives will have to be taken to reduce the high dependence on the corporate segment.
Moreover, the regulator too is not taking things easy. It is planning to accumulate Rs 80 crore-100 crore for an investor- education fund. According to officials connected with the development, this decision will be taken by the regulator in the next month. “The issue has been pending for many months and the corpus will be raised by Sebi from asset management companies. The corpus will be used only for providing education in mutual funds throughout the country.”

Currently, several big fund-houses conduct investor education and awareness in several parts of the country. “Sebi plans to raise 0.01% of the asset under management (AUM) of each and every fund house. However, other details such as when the amount will be collected and how it will be used, will be chalked out by the Sebi in the coming days,” said a member of Sebi’s mutual fund advisory committee.

Already, distributors have started to shun fund-schemes and the fund industry continued to witness a downfall of inflows in equity schemes. Investment in mutual-fund schemes also saw a sharp decline of 68% in November, to over Rs 45,100 crore over the previous month, as investors preferred to stay away from equity-based funds.

At the end of November 2009, investors poured in funds worth only Rs 45,124 crore into several mutual fund schemes, with the maximum infusion coming into fixed-income plans, according to the data provided by the Association of Mutual Funds in India’s (Amfi). At the end of October, the total inflow stood at Rs 1.41 lakh crore.

The message is very clear. Mutual funds will have to get sharper and increase their retail reach.

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