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Home / Opinion / Reducing choice, not well-being

One of my favourite sets of slides in my workshops on regulation in the retail financial sector is the one on choice. I begin with a slide with one bar of soap on it. Obviously some choice is needed. The next one has two bars and some smiley faces. Better. Next has six, even better. More smiles. The last slide has a wall full of soap cakes of different brands and a woman stands perplexed in front. This slide always gets a gasp from the audience because it brings home the point that there is a limit to the benefit of choice. Anybody who has grappled with deciding between still, sparkling and regular water will understand what I mean. Water was supposed to be water, and then the choice guys got to it as well. At what point does choice stop being a good thing?

Research done by Columbia University professor Sheena Iyengar, a leading expert on choice, shows that buyers freeze when faced with too much choice. Her famous jam experiment shows that when there are just six choices of jam at a supermarket tasting counter, 30% of the people who stop by, buy. But when there are 24 choices of jam, just 3% buy. Iyengar shows that what works for jam works for finance too and as choice points are added, the decision making reduces. For instance, in the US retirement plan, 401(k), when there are two funds available, 75% of the people participate, and when there are 59 funds, participation rates fall to about 60%.

Indian mutual funds face a similar problem of plenty. There are over 10,000 schemes including the various investment options that fall into many categories—each of which is defined differently by different fund houses. This is a legacy of the past when funds could charge investors for new fund offers which saw some wild fund launches that left the industry with too many similar schemes from a single fund house.

The problem with too many me-too funds is that they confuse investors. Is there really a need for two infrastructure funds? Or two tax-saving schemes in one fund house? Then there is the issue of launching new funds to grab the investor’s interest rather than selling already existing schemes. Differences that only fund houses can see become a reason to launch a new scheme. While innovation is a good goal to have, the financial sector has used this hammer to beat regulators into behaving without really showing if this ‘innovation’ was really window dressing. The transition from bank deposits and gold to a market-linked product is not easy—it is a difficult habit to inculcate and making the product choice so confusing works against the industry.

As an investor, I find the choice of funds bewildering. It is worse in the debt fund part of the market where choice is impossible without good advice. Can the problem of plenty be solved without killing the industry?

One possible route could be for the regulator to decide on product types. In the equity space there are well-defined buckets—large-cap, mid-cap, small-cap and combinations of these. Sector funds could be one bucket, so could thematic and go-anywhere funds. This list is not exhaustive, but indicative. A similar exercise could be done for debt funds. There could be another bucket for asset allocation funds that do a combo of various asset classes. Each bucket carries a unique risk-return metric that is easy for the investor to understand and has an optimal holding period assigned to it. Remember, a financial product is neither good nor bad, it is how it is sold and therefore, how it is used, that determines its efficacy. Using a long-term bond fund to count short-term returns will cause grief. Each fund house is allowed just one scheme in each bucket. If they have more than one, they must merge it. New fund houses or those with empty buckets can simply launch a new scheme on tap, without needing regulatory approval—if they check the regulatory boxes on features, they can simply launch the scheme.

If there is genuine innovation and a fund house discovers a new ‘bucket’, it can work with the Association of Mutual Funds of India to get the regulator to open up a new category of fund classification. I know this is a radical idea, but we may need to think out of the box if the problem of too much choice is to be addressed. Mutual funds in India are great products. We’ve got the product structure right, disclosures are reasonably good and there are two decades of performance to review that says good things about asset management here. Not only will a cleaner classification help the do-it-yourself investor, it will also help sellers of the product clear up the fog of confusion caused by too many products.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, Yale World Fellow 2011 and on the board of FPSB India. She can be reached at expenseaccount@livemint.com

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