If you have been investing in mutual funds (MF) regularly, you’re already spoilt for choice, with over 1,500 schemes spread across the 7.12 trillion Indian MF industry. And the shelf is about to get bigger and more crowded.

Shyamal Banerjee/Mint

Already two asset management companies (AMCs) have launched their operations recently. India Infoline Asset Management Co. Ltd (IIFL) launched its first scheme (India Infoline Nifty Exchange-Traded Fund; an exchange-traded fund, or ETF) on 12 October and Indiabulls Asset Management Co. Ltd launched its first scheme, Indiabulls Liquid Fund, on 24 October.

While the old-age AMCs boast of performance and a wide bouquet of funds, most new-age fund houses are going to look a bit different. They’re small and feisty, come with an army of their own distributors and won’t bombard you with many schemes like in the old days. Should you go for them?

In-house distribution and branch network

Most of the new AMCs that are hitting the market these days come with a strong distribution network. Indiabulls Financial Services—a non-banking financial company—has 170 branches, as per its website. “In the present times, depending on MF agents have not worked very well for fund houses as commissions have vanished. Hence, people with captive distribution are heading to open fund houses," says Abizer Diwanji, head (financial services), KPMG.

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Bank-sponsored fund houses are also busy harnessing their in-house distribution force. For instance, Union KBC Asset Management Co. Ltd that closed the new fund offer (NFO) of its first equity scheme in June 2011, will make its schemes available only through Union Bank of India’s branches for the next one-two years. Vivek Mhatre, head of treasury, Union Bank of India, had estimated at the time of launch (he was the general manager heading the retail, transaction banking and third-party products distribution at that time) that the bank expects to be “the exclusive distributor for the fund in the initial years".

It’s not just in-house distribution that entices new fund houses though. PPFAS aims to convert its existing portfolio management services (PMS) business into an MF. Having got its first round of licence earlier this year, the firm will eventually transfer all its existing PMS investors to the newly set up mutual fund and then shift focus to its MF venture. In other words, its present count of about 600 clients with a combined corpus size of about 350 crore would roughly be the corpus of its first equity scheme, if PPFAS should launch one today. “It is operationally easier for us to run a mutual fund type of a set-up as against a PMS set-up, wherein we have to maintain separate bank accounts and demat accounts for all our clients," says Rajeev Thakkar, chief executive officer, PPFAS, who will also head its new MF venture.

Plus, an MF’s minimum investment of just 5,000 compared with a proposal pending at the Securities Exchange Board of India (Sebi) that can increase the minimum entry requirement in a PMS to 25 lakh is another reason why it wants to shift focus to an MF, says Thakkar. PPFAS, though, would appoint external distributors when it enters the MF space as it doesn’t have an in-house distributor.

Affecting profitability

Earlier, when fund houses were allowed to charge entry loads (2.25% upfront charges imposed on investors at the time of investment as commission that used to be passed onto distributors), distributors were more willing to sell MF schemes. Things changed in August 2009 when Sebi abolished entry loads. Distributors switched to selling other products such as unit-linked insurance plans of insurance companies and MF inflows started to take a hit. To compensate, fund houses started paying upfront charges from their own earnings, a move that fund houses claim will hit their profitability.

Back-of-the-envelope calculations show that while under a no-load regime, it would take a well-managed AMC to start earning profits after about four years, at present it would take a new AMC of a similar stature to start earning profits after about six years if it has an in-house distribution force and about eight years if it has to depend on external distribution. These are rough numbers though and based on certain assumptions such as the number of schemes launched in the first 11 years, a high amount of churn in corpus and so on. Actual figures will vary from fund house to fund house.

“Those sponsors who have a strong balance sheet and distribution strength will survive in this business and these are the kind of entities that will aim to enter the MF industry," says Jain.

Passive funds

Some fund houses prefer to start operations by launching passively managed schemes such as index funds and ETFs, as opposed to actively managed schemes, because of a low cost structure and very little maintenance. Apart from IIFL that aims to focus only on ETFs for the next year or so, others such as Motilal Oswal and IDBI Asset Management Co. Ltd that entered the Indian MF space in July 2010 and June 2010, respectively, have focused only on passively managed schemes on the equity side so far.

Most of them, though, are open to launching actively managed schemes on the debt side. Their strategy is two-fold—launch low-cost funds and entice investors; and build a track record in the initial years by tracking the indices as closely as possible before they launch active funds.

For instance, IIFL has plans to launch a fixed maturity plan, monthly income plan and an equity scheme that will track a dividend yield index. ETFs and index funds are slowly gaining popularity in India. Launching low-cost passive funds may not be a bad idea after all. Between March 2010 and September 2011, the number of folios in the ETF space went up by 241% to 125,000 folios and the number of folios in the gold ETF space went up by 157% at 428,000 folios.

During this time, not only did ETF investments go up by the highest margin among all other categories of MFs, they were also one of the few categories to have grown positively in terms of folios. “Mutual fund houses are increasingly warming up to ETFs and passive funds, whether it’s a new fund house or an old one. Goldman Sachs Asset Management Co. Ltd acquiring the erstwhile Benchmark Asset Management Co. Ltd recently is a case in point. Going forward, the general expectation is that new fund houses will launch more ETFs and other passive funds," says Vivek Prasad, partner, PricewaterhouseCoopers Ltd.

Not all see bad economics in getting actively managed funds off the ground. Having just launched its liquid fund, Indiabulls AMC will launch a couple of debt schemes before it turns its attention to actively managed equity schemes. “We feel it is not the right time yet to launch equity funds, but when the volatility in the equity market settles down and things become clearer, we will launch equity funds" says Gagan Banga, chief executive of Indiabulls Financial Services Ltd.

What should you do?

The abolition of entry loads and volatile markets may have led to lower inflows for the MFs, but the good news is that funds have become more realistic about their survival, especially the new entrants.

Sebi, on its part, has also been cautious in giving MF licences to companies. Before the sponsor company sets up its AMC, it applies for an in-principle licence with Sebi by submitting various documents required to prove its track record. Sebi takes about a month to a year to do a background check of the sponsor company before it grants it an in-principle licence. PPFAS took about 14-15 months to get its own.

Then, the sponsor company sets up its AMC’s office infrastructure, appoints trustees, fund managers, custodians, registrars and transfer agents and again approaches Sebi for its final licence. Sebi officials personally visit the AMC offices to check if the AMC is operationally ready to launch a fund house. If it is satisfied, Sebi gives a go-ahead and the fund house is good to go.

AMCs, on their part, have realized that while the entry is easy, survival is tough. As a result, what you—the investor—will get is a fund house that will launch either innovative products or one that is committed for a long haul, or in many cases, both.