Fund houses claim that index funds don’t bring much revenue. Is that true?
The Indian mutual funds (MF) industry is a business of scale. Apart from one, the top most profitable asset management companies (AMCs) are not necessarily the top five biggest AMCs. They have a few things in common. First, their staff and establishment cost is very low. Second, their retail investor base is stable comprising people from smaller towns, who invest in systematic investment plans (SIP). Of course, their schemes perform well. If I can achieve retail penetration and can control my costs, I think I will be able to make decent revenue. Third, our scale. We are comfortably poised here as IDBI (Bank), our parent, has a large branch network. My cost of collection drops. Last is our staff cost. I am very conscious of the fact that I have to keep my staff cost low.
I also believe that investors would realize the value of index funds. Fund managers of actively managed schemes go all out and sell schemes in good markets, but stop meeting and talking to investors and distributors in falling markets. Not only do most of them find it hard to justify their performances in falling markets, they also can’t (reply to) the investors’ questions as to when the would they recover their money. Very often, decisions taken in good markets look disastrous in falling markets.
Index funds don’t have this problem. There aren’t any bad decisions as the fund manager just mimics the index. And if an index has to rise, some time, index funds will follow. That is why it is easier to explain an index fund in a falling market.
You seem to be focusing on falling markets. But aren’t MFs all about creating wealth over a long period of time? How do index funds fit in a rising market versus actively managed funds?
The thrust of an average retail investor should be an SIP, irrespective of rising and falling markets. When the markets start falling and the fund manager disappears, the retail investor loses confidence. He stops investing. The number of SIPs that get stopped in falling markets is not funny.
In a good market, frankly, I just have to make my product available. If my branding is good and I am visible, my product sells automatically. But how do I ensure that in a bad market, an SIP is not stopped? An index fund is logical to explain in a bad market—the investor just buys the index at a cheaper level.
Wouldn’t it be tough to convince distributors to sell index funds?
The main reason that actively managed funds are more popular is that up to late 1990s, the market was less efficient than it is today. In an efficient market, very few fund mangers are able to outperform the bellwether indices. We believe most distributors are converting to selling passively managed funds and we hope to benefit from this trend. Additionally, the industry has arrived at a consensus by which brokerages for equity funds are more or less uniform. And, therefore, there should be no financial disincentive to the distributor for selling a passive fund. Many large distributors have moved to the advisory fee model, which makes active and passive funds commercially neutral to them.
—Kayezad E. Adajania