Mutual funds in 2017: What next after the high performance?
Many events shaped mutual funds in this year which will influence the mutual fund industry in days to come.
Demonetisation pushed out money from tijoris to bank accounts. Indians had more investment in currency notes than in equity shares in November 2016. Indians were happy to invest in zero-return currency notes than in higher-return equity. But post-demonetization, there was a fundamental change in savings pattern—money started flowing from bank accounts to mutual funds over the course of the year. This pushed up equity inflows and mutual fund assets under management (AUM) to all time highs. In the past, I have often spoken about a financial tsunami coming into equity mutual funds. We are now seeing the first wave in the form of retail savings coming to equity mutual funds. We now do more business in one month than we used to in an entire year, just a few years ago. More importantly, unlike in the past when flows were driven by greed and past performances, this time, most of it is driven by maturity and hope about the future. This is demonstrated by the fact that a lot of this flow is coming through systematic investment plans (SIPs) and systematic transfer plans (STPs). SIPs from more than 15 million investors are bringing in more than Rs5,000 crore monthly in equity funds. A majority of this is for a duration of more than 3 years. Most investors do know that equity markets can be volatile, and that equity requires a long-term investment horizon. This flow was made possible by the combined efforts of the regulator, the distributors, Association of Mutual Funds of India (Amfi) and the fund houses.
Sebi has laid out regulations over the years to build confidence. Many international names have exited the business, without causing any disruption for investors. Such a regulatory environment gives confidence to investors. Over the years, distributors have taken mutual funds to every part of India. I write this piece from Guwahati where i have come to market mutual funds. Most of them have kept client interest in mind, and the trust built with the initial set of investors is bringing repeat business now.
Amfi has unleashed an investor education campaign to popularise mutual funds. The “Mutual Funds, Sahi Hai” campaign has touched investors across the country. Fund houses have delivered reasonable performance across debt and equity funds. This may sound look self-praise but it would be fair to say that many of our current generation fund managers will be remembered as legends just like Peter Lynch and Warren Buffett are.
Our task is cut out for the next year and beyond. We have to manage investor expectations. While a majority of investors are coming about the future, a minority indeed is coming looking at the past performance. We have to caution them about potential lower nominal returns as inflation has dropped and equity markets are little above fair value valuations. Many investors tend to view mutual funds as equity funds, and we need to market debt funds as we have done for equity funds, especially for retail investors. We need to stress on the need for asset allocation and longer-term investment horizon. We need to reinforce the message of regular investments, especially to investors semi-urban and rural areas so that they can share the benefits of equity returns. We have to expand the distribution network by enrolling new distributors. The gap between the number of insurance agents and mutual fund distributors needs to narrow down substantially for the funds industry to sustain its reach. There is a need to develop models for small-ticket investors, and empower smaller distributors through technology for better analytical skills.
Another major development was Sebi’s guidelines on consolidation of mutual fund schemes. This has ended the non-level playing field. There will now be appropriate comparison of performance across schemes, after the consolidation is completed. The main benefit of this will be simplicity of products. Instead of getting confused between multiple categories of funds like diversified large-cap, concentrated large-cap, value focussed large-cap, growth focussed large-cap, large-cap focussed large-cap.... Investors will instead be able to choose a simple large-cap fund. There is also a possibility that funds with bad performance will get merged with the good performers. This will suddenly make those fund houses that are merging many schemes, optically improve their past performance, which could make past performance irrelevant. Once scheme merger is complete, investors should be particularly cautious when evaluating past performance.
While Indian fund managers have consistently generated outperformance over benchmark indices, over the years, the alpha has been reducing as funds are managing bigger sizes and markets have become more efficient. In the future, to generate alpha, fund managers will have to learn the techniques of concentration, leverage and long short strategies. These skills are not easily available, and fund houses will have to develop or acquire such talent. Fund houses will also have to launch lower-cost products like index funds and exchange-traded funds (ETFs), like in the developed markets, to cater to a specific set of investors. The Employees’ Provident Fund Organisation (EPFO) has started investing in ETFs, which has boosted the ETF business for select fund houses. There is a need to diversify the ETF base so that new innovations like smart beta ETFs can be launched.
Mutual funds remain a low-cost, value-for-money product for the common man. The foundation has been laid for rapid growth in the years to come. From being a low single-digit percentage of bank deposits, mutual funds are now a double-digit percentage of bank deposits. It has the potential to overtake bank deposits. But we need to keep on evolving to add value to customers. That will in a true sense prove that the industry has moved from ‘Mutual fund investments are subject to market risk...’ to ‘Mutual Funds, Sahi Hai’.
Nilesh Shah, managing director, Kotak Mahindra Asset Management Co. Ltd