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We have seen a continuous erosion of equity assets in Indian mutual funds since 2008. Equity assets peaked at around 2.5 trillion to 2.6 trillion in January 2008. Between January 2006 and December 2007, the average (equity assets as a portion of overall assets) was about 38%. It went up to 45% or so once or twice in that period. The spiral of outflows that started then has continued till date at the rate of 2,000-3,000 crore per month on average. Today, despite the markets recently hitting all-time highs, we are still seeing outflows. Total equity assets today stand at just around 1.5 trillion, 17% of the total assets under management (AUM). In the same time, bank deposits have gone up from 30 trillion to 70 trillion, real estate is estimated to have attracted an additional 20 trillion and gold has seen flows of over 8 trillion. Non-equity assets of mutual funds (MFs) have also risen from around 3 trillion to 7.3 trillion. There are several reasons for this phenomenon.

The push product lost its push: For one thing, equities have never been in the mainstream of the Indian investment basket; most Indians have traditionally put their money in fixed deposits, real estate and gold. The first major move towards building an equity cult was during the last bull-market phase in 2003-2007. But even in that period, the flows into MF equity schemes went mainly to new fund offerings (NFOs) by asset management companies (AMCs) and not to existing equity schemes. The reason for this was simple. NFOs were allowed to charge investors a greater portion of their expenses than existing schemes. Entry loads were allowed in MFs, but to the extent of just around 2%. As such, attractive payouts to distributors were used to get investors into new equity schemes without the investor necessarily understanding the risk-reward payoff. MFs in general did not spend much to make equity schemes a pull product. Subsequently, as entry loads were abolished one by one, first from open-ended schemes and then closed-end schemes, the push became difficult. Distributors used to 5-6% commissions were unwilling to work for just 0.75-1%. The opportunistic behaviour of MFs in launching a large number of closed-end schemes once NFO expenses were banned in open-ended funds also hurt investors. Many distributors moved out from selling MFs and at the same time various asset managers started shutting down offices as inflows dropped. This created a situation in which investors had neither an AMC salesperson nor a distributor to guide them.

Large AMCs, that hold most of the equity assets, have seen a huge ramp-up in profitability over the last two years as product distribution expenses have gone down and historical assets have contributed towards fees. These AMCs have tried to boost profits in the short term where they could have used some of the money for investor education and attracting investors to MFs by showcasing long-term benefits. It is still not too late to do this as allocation to equity as a proportion of total asset allocation is very low today.

The Ulip disadvantage: It is a fact that most unit-linked insurance plans (Ulips), offered by insurance companies were sold as MF schemes. I myself came across a large number of investors in the good old days who used to tell me that distributors would come and show MF scheme performances in order to get them into Ulips. As a result, several thousand crores of investor money flowed into Ulips schemes that had huge costs associated with them. The costs were hidden as long as the markets were doing well and giving positive returns. However, as soon as the markets turned and started giving negative returns, the costs started becoming more and more visible. By the time the regulator stepped in to address the issue of mis-selling, investors had already put a lot of money into such schemes. The loss of money in these schemes has also hurt MFs as most investors who lost money in Ulips are wary of investing in equity schemes. I have not seen any AMC go out into the market to educate investors on the differences between MFs and Ulips in a big way and the fact that MFs have done much better than Ulips.

Pushing the most fancied scheme: This is one of the biggest flaws seen among most AMCs. Typically at one point of time a particular scheme of the MF will be doing well and the rest will be lagging behind. Rarely will we see that all the schemes doing well in their respective categories. Now good performance, even over short periods of time, creates a pull factor. Normally the sales force of AMCs will start pushing that particular scheme by showing its three-month, six-month, one-year performance to distributors and investors. For the distributor, too, it is easy to sell a product that is doing well in the immediately preceding period. As a result, normally we see that a particular scheme will be attracting most of the new money for that AMC. The entire concept of asset allocation and financial planning is given a go-by. Now when the performance reverses, as we have seen in a large number of cases, the earlier positivity becomes a negative as investors start asking questions.

It is as such important for investors to allocate funds properly. This requires a bit more effort from AMCs and advisers to the investors which they have to be willing to put in.

Distributors to advisers: Most MF distributors of the past have now become insurance agents, real estate brokers or are selling debt products that offer good commissions. Selling equity schemes via a push model is no longer viable for them and most of them are unable to move to a fee-based model and do not even have an inclination to do so. Real estate broking and insurance still offer huge upfront commissions. With the advent of direct plans and the option to use the stock exchanges to invest in MFs, there is now a need to create a pull factor. Pull is always more beneficial in the long run. Large AMCs, sitting on huge accumulated profits, need to invest more on investor seminars, education through social media and by expanding their own sales force, which they have been actually reducing for years. This will be extremely beneficial over the long run as the equity market cycle reverses. They need to remember that the cycle always turns.

Building expectations: This is one of the most important things for AMCs to do. I remember that in the good old days of the last bull phase it was easy to show past performance data where in some of the years of 2003-2007 the returns from some MF schemes were as high as 100% in a year. Now, such performances builds up unrealistic expectations in the minds of investors. It is important to tell the client about the historic long-term average returns and how over the long run it is very difficult for equities to return much more than nominal gross domestic product growth plus some addition for productivity improvements.

Overall, the MF industry needs to adapt to the new regulatory environment; it has been reluctant to do so till date. The industry also needs to devote more attention to investor education, not necessarily by spending huge amounts of money but by investing in human resources. It will also be important not to repeat the mistakes of the last cycle as a new bull phase begins so that a long-term equity cult is built in India, which normally is done by MFs in most countries.

Sandip Sabharwal is a Mumbai-based fund manager.

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