A to-do list for mutual funds in 2016

The mutual fund industry has grown at a rapid pace in the past two years and assets under management are at an all-time high. There are more than 42 million folios, 8.6 million-plus systematic investment plans (SIPs) investing more than 25,000 crore annually in equity funds. In the past 18 months, equity fund flows have been more than in the previous 10 years put together. Our funds have outperformed benchmark indices by a reasonable margin. We are now managing money for provident fund trusts. Well done, but the journey has only just begun.

The Securities and Exchange Board of India (Sebi) has carefully nurtured the industry over time and from a regulatory and compliance point of view, India is at par with the best in the world. And yet, the entire mutual fund industry is smaller than an LIC (Life Insurance Corporation of India) or an SBI (State Bank of India). Mutual funds have barely reached 1% of the population, if we remove multiple folios.

To a certain extent, there is an unfair race to grab a share of the big Indian savings pie. Real estate, gold, ponzi and betting market schemes are running a normal race with a head start of having little regulation to worry about. The mutual fund industry, on the other hand, is running a hurdle race with tough regulatory hoops.

The number of people who actively sell mutual funds are in the thousands, compared to the millions who sell insurance policies, real estate, gold and ponzi schemes. Add to this the fact that mutual fund agents are taxed more than tobacco products since they pay service tax to the government. There is the need to incentivise the mutual fund agent since we need this tribe to retain savings within India rather than it getting exported through gold imports.

Mutual funds have become a short-term vehicle rather than a long-term one. We look at transactions rather than relationships. Most of the competing products have a physical aspect attached to them, or have an implicit guarantee of the government, or a statutory push through at source, compulsory deduction or tax incentives. Mutual funds are marketed with jargon-laced facts without creating an emotional attachment, or by selling dreams like regular bonus declarations or redemption at the highest net asset value (NAV), however false such promises may be in real life.

Indian mutual funds will grow if the government gives it a push of compulsory-at-source deduction like the 401(k) plan in the US, or exclusive tax incentives.

People invest in financial products based on trust. Trust is built on understanding and simplicity. We have more than 2,100 schemes in the two primary asset classes of debt and equity. We have too many products leading to confusion, misinterpretation and under-information. Many of us need to consolidate and simplify our products so that investors can understand them better. Sebi is pushing for consolidation of schemes to make life simpler for investors. Hopefully, fund houses will rationalise their product portfolios soon.

Investor trust is built by consistent outperformance over benchmarks. In the coming year, mutual funds have to sharpen their credit assessment skills to comfort investors on the fixed income side. Mutual funds will have to ensure that performance divergence between open-ended and closed-end schemes, large-size funds and small-size funds, and funds receiving inflows and those seeing outflows is explainable. The industry lost a lot of trust during the technology bubble by going wrong on the business as well as valuation sides. We have now learnt to pick the right businesses. We now need to ensure that we don’t go wrong on valuations.

A lot of flow has come into equity funds in the calender years 2014 and 2015. But investors’ return expectations have probably not been met. Plus, there are concerns around the pace of the US interest rate hike, China slowing down, uncertainty on reforms push in India, deferment of Fiscal Responsibility and Budget Management targets due to the 7th Pay Commission recommendations, continuous foreign institutional investor selling and tepid corporate earnings growth. We need to work harder to reach out to distributors and investors and hold their hands during this difficult period. We have our job cut out to keep the faith and investors’ money in the market for next year.

How successful we are will determine not only the fate of the industry, but also whether ownership of Indian equity remains with Indian retail investors.

Nilesh Shah, managing director, Kotak Mahindra Asset Management.