Ready to reset

As the new head of Securities and Exchange Board of India (SEBI), U K Sinha, gets down to do serious business, one of his focus areas is to revitalise the mutual fund industry. After scripting a success story over a decade, the industry witnessed a slump last year.

While India-focused funds clearly dominated the list of top performing open-end equity funds globally over 15 years, by notching up 14 of the top 25 spots, what spelled alarm bells for the Rs 6.65-lakh crore mutual fund industry was the fact that, in 2010, no Indian funds made it to the list of top 25 or even top 100 performers globally, according to the latest report by Morningstar and SBI Magnum Sector Umbrella Contra Div.

The Study On Relative Performance of Indian Equity Funds Versus Global Equity Funds, December 2010 unfolds the story of Indian mutual fund industry, which almost battled for survival in 2010. But experts are hopeful that 2011 will be the year of much needed consolidation for the industry.

Market matrix

“The year 2010 can be well be written off as the annus horribilis for mutual funds,” confirms Sanjay Sinha, chief executive officer, L&T Mutual Fund. “Industry had large volume of redemption, which was very unfortunate. Part of redemption was because of the fear that market levels were not sustainable and this prompted exit by investors.” However, Sinha adds that this fear psychosis is largely playing out. In November 2010 net outflows from equity schemes were down to Rs 41 crore as compared to Rs 7,011 crore in September and Rs 2,869 crore in October.

For observers, it all began in 2009, when SEBI banned the entry load on MF schemes, which spelled that MF houses pay all upfront incentives and commissions to distributors from their own pockets. In due course, distribution agents switched to promote portfolio management services products by banks and private parties including stocks and insurance.

Dhirendra Kumar, CEO of Value Research, says, that the present stagnation is on account of industry churn. Kumar explains that 2003-07 witnessed unprecedented bull run for the segment, in which investors did not ask questions and nor did the regulators.The year 2008 served as the wake up call for the industry on account of overall market decline, 2009 saw regulatory changes with SEBI abolishing entry load and tightening fixed income funds that turning 2010 into a year of pain for the industry with less fresh investment coming in and old investors getting out as they were mis-sold in 2008. “Clearly a year of stagnation.”

Ravi Trivedy, an executive director with KPMG, points out that the current crisis in the industry emanates from the commission structure changing in 2009 wherein investors have to pay 1.5% advisory fee to the distributor/adviser. “This in turn became a hindrance for the investor who had to cut a separate cheque for the distributor for his advice, escalating into a scenario where mutual funds could not scale into a volume business. The second reason is that unlike the insurance business, which built large dedicated sales engines, the MF industry developed an open architecture model based on commissions, which switched to selling other products as MF commissions are no longer lucrative.”

Trivedy adds that it’s not that the mutual fund investment space is shrinking, but it’s definitely stagnating. The Indian market is and has been a sales-led market. Until the sales guys are incentivised, the present mutual fund market dynamics will not change.

However, comparing mutual fund with insurance products, Punit Shah, head of financial services tax at KPMG, agrees that mutual funds will remain better option for retail investors and fixed income plans will grow and SIPs will become popular. “ULIPs may become less attractive investment avenues due to some of the regulatory changes imposed by IRDA after the SEBI and IRDA issues.”

Just when equity funds were worst hit, Kalpen Parekh, deputy CEO of IDFC Mutual Fund, says, that investor preferences evolved considerably with hybrid funds developing as the best bet. “A lot of investment happened in hybrid funds—debt, equity, ETFs and bonds—to enable a wider investment base and better returns. Many fund houses launched asset allocation funds for diversified investments. The hybrid category is estimated at Rs 30,000 crore and is growing month-on-month.”

Parekh acknowledges that the soar spots were indeed equity funds that witnessed massive outflows. “Outflows were on account of a peaking market and retail investors existing at its back. However, in the last two months the market has stabilised with new investors coming to the fold and old investors redeeming less.”

Way forward

On a similar note, Vicky Mehta, a senior research analyst with Morningstar India, says, that he is optimistic about the future of mutual funds in India. “A significant portion of the Indian investing community doesn’t invest in mutual funds, so clearly there is a huge potential that remains untapped and they are an apt avenue for retail investors to invest in market-linked investment avenues.”

Mehta adds, that when SEBI banned entry loads, a doomsday scenario was predicted from several quarters. “This was nothing more than resistance to the fact that status quo was being challenged. Now, fund houses will have to compete by ensuring that their offerings are well-managed and in investors’ best interests. There was perhaps an element of ‘easy money’ in the form of new fund offers (NFOs), which is now a thing of the past. But that is barely a cause for concern.

Regulatory changes introduced in recent past have only helped the investor’s cause. And if something is right for the investor, it’s right for everyone else. These changes will put the mutual fund industry on a strong footing in the years to come.”

Kumar predicts a revival in 2011 with steady flows. “It will be a consolidation phase. But it is unlikely to be a high growth business. The biggest failure for mutual fund industry is that they are not trusted by the regulator, there is an element of suspicion around them. And the most critical limitation is that they have not been able to grow into a volume business as the right apparatus, in the form of economic push, is missing. Till this apparatus is not developed, MF will not be able to spread reach.”

In similar vein, Sinha adds that distribution will be the biggest challenge for the industry. “Industry will have to devise a cost-effective distribution method and the solution to this will come from technology that will touch a larger base. Upgradation of the stock exchange platform and the rising acceptance of paperless forms of investments by distributors and investors will also play a cardinal role in expanding base.”

A red flag, however, Sinha feels, are the new KYC norms, which may cause some obstruction in the flows to mutual funds as they involve considerable paper work to be completed by even the existing mutual fund investors who want to make additional investments.

On the exodus of top managers from the industry, Sinha explains, that departure of fund managers will be part and parcel of a growing industry. There is scope for a large number of new managers to step into their shoes, which is a good development, given the fact that the industry has to expand its footprint in terms of the investor base as well as assets under management.

However, Sinha adds that for 2011, larger optimism comes from the growing base of investors who are choosing SIPs. “The industry runs close to 50 lakh SIP accounts, which are growing month-on-month. This pattern of investment is more structural as compared to previous instances where investors chose mutual funds only as a opportunistic tool to participate in market rally.”

Source: http://www.financialexpress.com/news/ready-to-reset/752268/#