Mutual fund expenses must reflect India’s realities
If large cap funds continue to struggle to deliver alpha net of costs, the pressure on costs will automatically hit the industry.
When a prominent Indian film director was asked why we don’t make films that win Oscars, he responded that the Indian film industry’s job is to address the domestic audience, and India has a large one at that. In the last month, the vivid debate around mutual fund (MF) expenses has focused on whether India is cheap or expensive relative to various global markets. However, the domestic asset management industry is better off answering the question—what is right for our markets and for our investors?
India has realities that are unique to it. MF penetration to GDP is less than 12% today, well below that of the US and the UK, and the global average of 60%. According to forecasts by Nomura, in FY35, we will be under 40%, still miles to go against the rest of the world. Our problem is taking a high-quality, well-regulated financial product to a large mass of retail consumers, who account for at best 25% of the entire MF assets today. And for this industry to grow exponentially, all three players—investors, advisers, and AMCs—need to succeed in the long term.
Are investors being treated fairly at the current level of expense ratios in MFs? Largely yes. The “right expense ratio” is one that is fair to an investor, given the value that is being delivered by the asset manager. For instance, in an equity fund, net of all fees, an investor must see meaningful alpha relative to the benchmark. Domestic funds have delivered meaningful alpha net of fees in most equity categories.
In fixed income, expenses should be commensurate to the level of total returns, and in many of the major categories, particularly on the shorter end, we are there. A few anomalies do exist—pure large-cap funds and long duration income funds—where net investor returns today may not justify the large expense ratios. Broadly, however, with no entry loads, no performance fees, limited exit loads and a favourable tax structure for long-term investors, MFs are still the most cost efficient financial product today for an Indian investor.
Expense ratios must also incorporate a fair cost of distribution. The understanding, if not awareness, of MFs is still very patchy. Even in most urban centres, at investor education initiatives, I still field questions about the difference between an SIP and an MF, and whether a first-time investor should invest 100% of his corpus in a small-cap fund. Choosing the right funds is not as simple as choosing the right fixed deposit. Many are first-time investors, and the right financial planning, guidance and advice is critical to a successful investment experience. In fact, for MFs to reach the mass they should, India needs 1 million ARN holders who have an incentive to service retail investors. And for any adviser, there is a cost of servicing a retail customer that is non-trivial, and frankly large compared to the commissions or advisory fees earned for an SIP transaction. In a medical equivalent, MFs today are still complex antibiotics where the role of the doctor is critical, rather than a paracetamol that can be bought over the counter.
Ultimately, consumers in any industry vote with their feet. As the market grows, penetration increases, and consumers become savvier and costs adjust downward. Telecom is the best example—with the Jio movement, market forces have brought mobile phone pricing down and how. This is already happening in liquid funds, the paracetamol equivalent of mutual funds. Customers are like sophisticated corporates who now buy directly; expense ratios are well under any regulated minimums; and the product is commoditized with no distribution channel required. If large cap funds continue to struggle to deliver alpha net of costs, the pressure on costs will automatically hit the industry. Market forces are the best arbitrator of costs. As an ecosystem, let us spend our time fighting the battle to expand the pie by reaching more investors, and let investors optimize what kind of pie they want to eat.
Radhika Gupta is chief executive officer, Edelweiss Asset Management Ltd. Views expressed are personal
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