Entry load or not, most foreign funds got it wrong

High cost and similar performance from domestic players played spoilsport

“When a fund house like Fidelity exits, it does not augur well for the Indian mutual fund industry,” says the chief executive officer of a leading fund house. But, he is quick to add, exits of large and well-known foreign fund houses from India are common.

 

He is right. Since 1993, when the MF sector was opened for private and foreign players, there have been exits by at least 10 high-profile foreign entities. Many were standalone ones. The trend started with the sale of Kothari Pioneer (Pioneer of the US), bought by Franklin Templeton, one of the few foreign successes. Pioneer has recently re-entered by buying a stake in Bank of Baroda’s MF arm. There are many others like ANZ Grindlays, Standard Chartered, Aegon, and DBS, which have completely exited.

According to experts, most foreign fund houses, especially standalone ones, have found the going difficult. “Most were unable to attain a critical mass – Rs 10,000 to Rs 15,000 crore – in assets, which hurt them badly. Even their cost structure is much higher. Yes, business models had to be tweaked after the entry load ban. But, that’s just one part of the story,” says Rajiv Deep Bajaj, CEO, Bajaj Capital, an MF distributor.
 

The entry load ban was implemented in August 2009, but it did not lead to huge losses for most fund houses. In fact, the top five continued to make money despite the tough regime. HDFC and Birla Sunlife doubled and trebled profits. On the other hand, already loss-making fund houses continued to perform badly. There were new players such as Axis, Mirae and L&T which entered during this tough phase and are still in the red.

Things weren't much different even without the entry load ban. While Fidelity’s asset quality, in terms of money in equities, is much better, there are others which have spent money without actually collecting it.

Cost issue In addition, costs are an issue. For instance, in 2010-11, Fidelity’s staff cost was as high as Rs 68 crore, whereas its income was Rs 75 crore and its assets Rs 8,880 crore. Similarly, ING’s income was Rs 74 crore, staff cost Rs 30 crore and assets Rs 1,559 crore. HDFC’s income was Rs 680 crore, staff cost, Rs 85 crore and assets Rs 88,737 crore, thereby making it more efficient.

The problem lies there: The cost-benefit matrix is not in the favour of many. “Fund houses which entered just before or have seen at least one good bull run should be doing much better. However, there could be a problem of managing costs and the inability of some to adjust to Indian conditions,” said Arindam Ghosh, CEO, Mirae Asset. The Sensex rose from 6,000 to 21,000 between January 2004 and January 2008, almost 3.5 times, a really good time for fund houses. He notes that besides the bull run, the other growth drivers no longer exist.

The fact is that the entire MF industry hasn’t suffered. Of 42 fund houses, 22 had accumulated losses of Rs 1,729 crore till March 2011. Eighteen others had piled accumulated profits of Rs 2,656 crore. Given that accumulated profits are post-dividend, the latter’s would be higher. Importantly, 14 of these are purely or predominantly Indian players, according to the classification of the Association of Mutual Funds in India.

The top three profit makers – UTI Mutual Fund, Reliance Capital Asset Management and HDFC Asset Management – have contributed a whopping 63 per cent to the profits of the industry. (UTI has been there for almost half a century, so its profits have been accumulated over the years).

Clearly, there is a disconnect somewhere. Mirae’s Ghosh says the top 10 players globally are standalone ones, that perform much better those with bank or corporate house affiliations. “In Asia, the trend is the reverse. It is a function of the stage an economy is in,” he says.

Other experts feel that there isn’t much difference between a foreign and Indian entity in terms of performance. “With performance being almost the same, reach is the key for success. This is where Indian fund houses, especially bank-sponsored ones, have scored,” said Rajiv Anand, CEO, Axis MF.

Most say the business environment is more high-cost now. As the CEO of a leading fund house said, “If one is earning Rs 1 and spending more than that in fees and brokerage costs, there is a problem. In such times, the promoter’s patience is put to test.” A test in which many foreign fund houses have been failing for almost two decades.

Source: http://www.business-standard.com/india/news/entry-load-or-not-most-foreign-funds-got-it-wrong-/463910/

Mass exit by small investors

High volatility in stock prices and resultant erosion of wealth in mutual funds has forced as many as 16 lakh investors operating through systematic investment plans (SIP) to close their accounts.

This exodus has taken place over the last year alone by investors who have been putting monthly recurring deposits with mutual funds to buy stocks spanning over a longer period to make money.

But with all calculations going haywire and fund managers remaining ineffective to provide expected returns, investors who are now looking for short-term returns are shifting their funds to secured and high-yielding modes of investment such as bonds, bank deposits, bullion and even real estate.

Last year, Indian stocks lost nearly quarter of their value due to a prolonged bearish market and overall grim economic outlook in India and abroad.

"Most SIPs happened between 2006 and 2008. Those who started in 2007-08 are mostly into losses because the market has been in a bad shape. People who are constantly witnessing value erosion have no motivation to stay invested," said Waqar Naqvi, chief executive officer (CEO), Taurus Mutual Fund, one of India's fastest growing asset management companies with over Rs.5,000 crore under management.

According to rough estimates, there could be over 1.5 crore SIP accounts opened with 40 mutual funds operating in India and the reported 16 lakh SIP account closure in 2011 accounts for nearly 10 per cent of this segment.

"Most retail investors have lost faith in the capital market. SIPs are the last to exit. Investors are exiting because there has been no capital protection in India. Currently, all policies are pro derivatives and investors are not comfortable with derivative stocks where fluctuation is very high," said Kishor Ostwal, chairman and managing director (CMD), CNI Research.

"Investors do not like to risk their hard-earned money in a market which could be easily rigged. On the other hand, people are witnessing value appreciation in gold and real estate. Thus, they have shifted," Ostwal added.

Another factor in the fast depletion of SIP investment is the drastic reduction in the number of distributors of mutual fund products. Many investors have stopped paying due to absence of service from distributors said officials.

"Due to the hefty upfront commission offered by industry players, many unscrupulous distributors had opened fraudulent SIP accounts and soon after pocketing the commission, the accounts were made to close down causing loss to the industry. The industry must stop this practice immediately," said an industry official asking not to be named.

Investors are lured by the exceedingly high performance of other asset classes. Last year, gold prices appreciated by over 30 per cent and real estate prices, barring metros, have been on a constant rise. This has opened up investment opportunities for people, said experts.

Apart from this, debt investments such as fixed deposits and bonds have become attractive of late where there has been a guarantee in return as against the uncertainty in equity investments. The bonds issued by public sector and private enterprises have been sold out in the recent past due to a trust deficit in the capital market.

Whatever may be the reason, investors are fast losing confidence in the capital market and unless Securities and Exchange Board of India (Sebi) brings in radical reforms, they would hardly return.

Source: http://indiatoday.intoday.in/story/mass-exit-by-small-investors/1/172444.html

Behind the fear of debt

Fears are being expressed in official policy circles that the country's dependence on foreign debt, as opposed to foreign investment, to finance the external deficit is increasing, leading to specific policy responses. C.P. Chandrasekhar and Jayati Ghosh examine these fears and assess the responses.

It began with the Reserve Bank of India's third quarter 2011-12 Review of Macroeconomic and Monetary Developments released on January 23, 2012.

Its assessment of the situation in India's external sector noted that: “Risk aversion in the global financial markets has slackened the pace of capital flows to India… If the pace of FDI inflows does not pick up once again and FII equity inflows revert to the decelerating trend, CAD (current account deficit) may have to be largely financed through debt creating flows in the coming quarters.”

It also underlined the fact that signs of a recent revival of FII inflows were largely on account of investment in debt instruments.

A few days later, the RBI Governor, Dr D. Subbarao, referring to the rise in debt flows, publicly emphasised that India has “a preference for non-debt flows over debt flows”, and “within non-debt flows, more of FDI”.

Along with the expression of such fears, the government has been liberalising foreign investment rules to attract equity inflows in lieu of debt. The most recent such policy allows individual investors to invest in equity.

The justification provided for these fears and policies is the evidence that investments in Indian equity have decelerated during the first half of fiscal year 2011-12 when compared with the recent past.

In particular, there has been a collapse of foreign portfolio investment flows, leading to an overall fall in external investment in equity.

The RBI has released some preliminary figures for the third quarter of 2011-12. These figures also point to a decline in monthly average inflows of foreign equity investments during September-November in the case of direct investment and September to December 2011 in the case of portfolio investments. But the decline is by no means dramatic.

foreign debt inflows

These changes have been occurring at a time when the external current account deficit, which had fallen in the second half of fiscal 2010-11, has risen significantly.

As a result, a rising share of a rising deficit is being financed with non-equity flows.

The ratio of direct and equity investment flows to the current account deficit in India appears to have shifted downwards over a relatively short period of time.

The conclusion arrived at is that India has had to increase its reliance on debt creating flows to finance its current account deficit.

Supporting that is the evidence that inflows in the form of loans and banking capital have together risen quite sharply during the first two quarters of this fiscal year.

Though fully collated figures for the period since September 2011 have yet to be released, there are reports that these tendencies have only intensified more recently.

According to one report, during calendar year 2011 as a whole, foreign debt inflows amounted to $8.65 billion, out of which as much as $4.18 billion came in the month of December. On the other hand, calendar 2011 is said to have recorded a net outflow of equity investments to the tune of $357 million.

Moreover, foreign debt inflows in January are placed at $3.21 billion against a much smaller $1.7 billion of equity inflows.

Finally, SEBI figures on net FII investment suggest that while FII investments in equity have been low or negative for much of the past 14 months, FII purchases of debt instruments have spiked during December 2011 and January 2012.

Nod for QFIs

What does this combination of figures say about the capital inflows into the country and their role in financing the current account deficit? To start with, they do point to the fact that, over the last year, inflows of equity investment have been less buoyant than they were prior to the financial crisis and during the post crisis recovery.

Secondly, they indicate that one consequence of this has been an enhanced role for foreign debt in financing the current account deficit.

However, this does not mean that India is having any difficulty financing its current account deficit, nor that increased reliance on debt is driven purely by the need to finance the current account deficit.

Rather, large Indian firms are choosing to borrow abroad to benefit from the substantially lower interest rates in international markets as compared with India.

Moreover, the government had, in December, deregulated interest rates on Non-Resident (External) rupee (NRE) deposits and Ordinary Non-Resident (NRO) Accounts, triggering a chase for non-resident deposits among Indian banks.

According to reports, there has since been a surge in NRI deposits, encouraged by the opportunity to earn profits through arbitrage. This makes the volume of debt inflow much greater than needed to finance the current account gap.

As a result, foreign exchange reserves have risen and remained at relatively high levels.

Despite these factors, the government and the RBI appear to be using the shift away from equity to debt inflows to liberalise the terms for foreign equity investment inflows.

Flagging this tendency was the announcement on New Year's day, 2012, that a new group of foreign investors identified as Qualified Foreign Investors (QFIs) are to be permitted to invest directly in India's equity markets.

The definition of who ‘qualifies' is rather broad: it covers any individual, group or association resident in a foreign country that complies with the Financial Action Task Force's (FATF) standards and is a signatory to the multilateral Memorandum of Understanding of the International Organisation of Securities Commissions (IOSCO), dealing with regulation of securities markets.

Rationale behind move

Measures such as these are partly explained by the UPA government's desire to establish that it has not slowed down on reform and to counter the view that a form of “policy paralysis” afflicts it.

But they are also driven by the need to reverse the slowdown in inflows of foreign portfolio investment.

The decline in FII inflows has been attributed to developments abroad, which required foreign institutional investors to book profits in India and repatriate their funds to meet commitments or cover losses at home.

The presumption appears to be that individual investors would not be affected by such compulsions.

The government's press release announcing the new QFI policy declares that the object of the measure is to “to widen the class of investors, attract more foreign funds, and reduce market volatility”.

In the last Budget, these investors had been allowed to invest in Indian Mutual Fund Schemes. The recent announcement takes this a step further and treats them on a par with FIIs.

The government's view that QFIs would make up for any loss of FII inflows and that their investment would be characterised by greater stability has to be tested. But the factors motivating its decision are clear.

Call for caution

One danger is that the new measure allows direct access to equity markets to entities not regulated in their home country.

When India first began permitting foreign investment in the equity market, the FII category was created to ensure that only entities that were regulated in their home countries would be permitted to register and trade in India. The logic was clear.

Since it is impossible for Indian regulators to fully rein in these global players and impose conditions on their financing, trading and accounting practices, controlling unbridled speculation required them to be regulated at the point of origin.

But this kind of derivative regulatory control can apply, if at all, only to institutional investors.

Individual investors cannot be subject to such rules even in their home country and allowing them to enter amounts to giving up the requirement that only foreign entities subject to some discipline and prudential regulation should be allowed to trade in Indian markets.

This is of relevance because individual investors are unlikely to enter India and invest in equity to hold it with the intention of earning dividend incomes.

The exchange rate and other risks would be deterrents to such long-term commitments.

If such investors do come it would be with the intent of reaping capital gains through short-term trades.

Thus, to the extent that the measure is successful, it would mark a transition towards allowing speculative players greater presence in Indian markets.

Defending that on the grounds that it would help reduce dependence on debt is indeed questionable.

Source: http://www.thehindubusinessline.com/opinion/columns/c-p-chandrasekhar/article2866260.ece?homepage=true