Mumbai: New fund offers, or NFOs, a favourite money-raising vehicle of the Rs6.97 trillion Indian mutual fund industry, are facing an uncertain future.
Investor-friendly: Before 1 August, investors paid an average 2.25% of the sum invested as entry load while buying mutual fund units from distributors. Sebi has now barred distributors from taking any such fees. Abhijit Bhatlekar / Mint
While the first blow was dealt by the capital market regulator, the Securities and Exchange Board of India (Sebi), in January 2008 when it banned NFOs from amortizing issue expenses of up to 6% for close-ended schemes, a recent policy decision to do away with entry loads is the final nail in the coffin of new funds, experts said.
The contribution of NFOs to total money received by fund houses in the first seven months of 2009, net of redemptions, has dropped to 44%. In the past few years, NFOs were responsible for 100% of net funds flow to the industry, and at times even exceeded new inflows. Net inflows is the money that flows from new schemes as well as old schemes, minus redemptions from old schemes.
Up to July, NFOs had brought Rs3,274 crore into the equity schemes of the mutual fund industry, while the total inflow has been Rs7,431 crore, net of redemptions.
Amortization is a process of recovering acquisition cost over a period of time. Till 2007, fund houses were allowed to charge 6% as marketing expenses for new fund offers of closed-ended schemes, spread over the lifespan of the schemes, typically three or five years.
An entry load is the commission that an investor has to pay a distributor to purchase units. Before 1 August, investors were paying an average 2.25% of the sum invested as entry load while buying mutual fund units from distributors.
Funds and distributors will find it easier and cheaper to sell existing schemes with a proven track records than starting new themes, going through regulatory approvals and hosting roadshows for new schemes, experts said.
“The distributor is now answerable to the investors for the advice given and, therefore, is likely to recommend a scheme with a track record than an NFO, which is just a promise,” said Nipun Mehta, head, private banking, Societe Generale SA.
Typically, a fund house needs a minimum of three months to float an NFO for creating a theme, preparing the offer document and getting the regulatory approvals.
Advisers who plan investment strategies for clients agree that the enthusiasm for NFOs will decline. Vishal Dhawan, director, Plan Ahead Wealth Advisors Ltd, a Mumbai-based investment advisor, said, “The NFO mania will come down as the ability for asset management companies to pay the distributors is reduced. The advisers may turn neutral between (selling) new fund offers and existing schemes, since the incentive will be much lesser. They might be happier selling time-tested schemes than new ones.”
According to fund managers, new offers could come only if the theme is genuine. “If the NFO is a new idea, then it could sell; if it’s an existing idea, the fund has to work harder to sell. An NFO is a promise while an existing scheme has a track record of delivery. The distributor would find it more reasonable to sell the latter,” said Saurabh Nanavati, chief executive officer, Religare Asset Management Ltd, which manages at least Rs12,240 crore worth of assets.
Sanjay Santhanam, an industry veteran and a former mutual fund marketing head of Canara Robeco Asset Management Ltd, said: “The new Sebi rule banning entry load has very clearly discouraged the NFO business. Earlier, people would come up with an NFO for no reason at all; now they need to really innovate.”
According to Santhanam, the moment Sebi took away the 6% amortization of issue expenses, the NFO business took the first hit.
In 2008, NFOs’ contribution dropped to 82% of the net inflows into the mutual funds, marking the beginning of the decline in contribution from NFOs to overall fund inflows.
Between 2005 and 2007, new fund offers accounted for practically the entire inflow into the mutual fund industry. In fact, in those years, NFOs accounted for more than 100% of the total inflows, net of redemptions, as sellers went for churning investors from existing schemes into new schemes, often for the commission.
In 2005, when new equity scheme launches saw an inflow of Rs25,225 crore, net inflow to the industry was much less at Rs21,951 crore. This means existing schemes saw redemption of Rs3,274 crore net of inflows.
Similarly, in 2006, NFOs brought in Rs36,741 crore while existing schemes lost around Rs3,100 crore, taking the net inflow figure to Rs33,665 crore.
In 2007, new schemes inflows were at Rs29,287 crore while the net inflows were far lower at Rs21,071 crore.
Some fund houses have already begun promoting their existing schemes aggressively. For instance, Birla Sunlife Asset Management Ltd, which manages assets of Rs57,331 crore, saw an inflow of Rs160 crore last month into its Birla Sunlife Frontline Equity fund, a diversified equity scheme, while some NFOs that are currently open are struggling to cross the Rs100-crore mark.
A. Balasubramanian, chief executive, Birla Sunlife Asset Management, said he will continue to promote the existing schemes. “I think going ahead, people will launch NFOs only if they need to fill a gap in their product portfolio. Our existing funds have been seeing a lot of inflows. We are focusing on existing products, promoting themes like diversified equity, infrastructure, mid-caps and monthly income plans.”
Indeed, NFOs played an important role in spreading the mutual fund culture and that will now be missed. Hemant Rastogi, chief executive officer of Wise Invest Advisors, a Mumbai-based investment advisory, said: “If you look at the NFO data, subscriptions have come in from remote places. These subscriptions come in because there was some incentive to sell (funds). But now whatever little service these small distributors were doing to the unserved areas will get affected.”
According to industry lobby group Association of Mutual Funds of India, around 20% of the assets under management come from towns while the top eight cities of India account for 80% of the assets.
“A decade ago, we took a policy decision of incentivizing the distributors to expand the industry and educate the investors. Now, we have discovered that paying the distributor has not worked. How do you expand the equity market participation and educate investors?” said Santhanam. According to him, the corpus of the investor education fund that is lying with the government could be used to do that.
In the earlier regime, NFOs made happy both fund houses and distributors. While distributors got upfront commissions for selling new funds and top performing agents got special gifts and even fund house-sponsored foreign tours, the fund houses could expand their asset base quickly through NFOs. This led to a proliferation of NFOs, but not always in the interest of investors.
Between August 2007 and January 2008, when India’s benchmark equity index, the Sensex, rose nearly 40% from 14,935 points to 21,206, new schemes mopped up Rs22,815 crore.
While distributors and fund houses earned commissions and investment management fees, the investors have not yet recovered their losses.
This prompted Sebi board member M.S. Sahoo to criticize the fund houses. “Investors have to choose between the devil and the deep sea. As if 2,000 different stocks weren’t enough, fund houses have launched nearly 1,000 schemes and have another 5,000 options like quarterly, half-yearly, long term, short term and so on. This confuses the investor completely,” Sahoo had said in March at a mutual funds awards function organized by Crisil Ltd and CNBC-TV18.
Sahoo had in fact asked fund managers to think about investors, whose wealth they were managing, and wondered if it was the wealth of the distributors that was the priority.
Sebi rules allow mutual funds to launch new schemes when they have a unique investment objective, distinctively different from a fund house’s existing suite of products. But often this avenue was misused. While names were different, suggesting new themes, the fine print of NFOs always suggested that they could invest in an array of stocks from different sectors, effectively making them diversified equity schemes. A few NFOs, named wild animals, never roared.
While a section of investors gets attracted to the themes, others lap up NFOs as they are usually priced at Rs10, while existing schemes would sell at a higher net asset value, depending on performance.
Some investors even buy new funds with a trading perspective and expect them to list at a premium on the listing day along the lines of initial public offers. Fund houses and distributors have not been active in discouraging this misconception and often used it to their advantage to promote NFOs because of the incentives involved.