9 min read.Updated: 07 Oct 2021, 01:31 AM ISTNeil Borate
A string of new entrants want to radically rejig the world of mutual funds. Will they succeed?
What remains to be seen is whether all of this is merely big talk or will the ground beneath India’s growing club of investors indeed shift towards a positive, consumer-friendly direction
In early September, Flipkart co-founder and former chairman Sachin Bansal played a masterstroke in the mutual fund space. A regulatory filing by his group’s mutual fund business—Navi Asset Management Company—showed that it would soon bring Vanguard’s funds to Indian investors. Founded by legendary investor John C. Bogle, Vanguard is a passive investing behemoth with a huge fan following all around the world and Bansal was set to bring its products to India.
Navi’s push for Vanguard is just the latest in a series of nascent yet highly disruptive moves to rock India’s usually conservative and stable mutual fund industry, which has until now been dominated by a few large bank-owned asset managers.
The winds of change started to blow in December 2020, when a new circular from the market regulator Securities and Exchange Board of India (Sebi) allowed fintechs to launch their own mutual fund products—even if they weren’t profitable. Sebi, however, mandated that such new-age asset management companies (AMCs) should have a net worth of at least ₹100 crore (up from the ₹50 crore that is currently needed for a regular AMC). This newly codified minimum net worth must be maintained until the new AMC turns a profit for at least five consecutive years.
Following the Sebi circular, an industry which was already witnessing heightened interest from fintechs saw a mini explosion of new entrants or wannabe entrants who are waiting in line for a license to operate. Prominent upstarts who have received a brand-new license in recent months are discount brokerage Zerodha, Prashant Khemka’s White Oak Capital, Bansal’s Navi Mutual Fund and NJ Mutual Fund, which is owned by the eponymous MF distribution company.
Other prominent individuals who are waiting in the wings are Deepak Shenoy of Capital Mind, noted investor Rakesh Jhunjhunwala and Helios Capital founder Samir Arora.
Passive investing (tracking an index instead of actively picking particular stocks) is a key element of the newcomers’ strategy. A focus on international funds and bringing down expense ratios are other cogs. Several other cards up their sleeves are yet to be revealed. One thing is certain though: the blasé world of mutual funds is in for some big shifts.
“We have treated India as one uniform market and painted all (the) investors in India with the same brush. A lot of innovation is waiting to happen," said Saurabh Jain,managing director and chief executive officer, Navi Mutual Fund. “A mutual fund portfolio should be like a subway sandwich. You choose your own topping and sauces according to your risk appetite and goals. The products that we have filed for so far are reflective of that (philosophy)," he added.
Similar to the banking sector, the realm of mutual funds has been a tightly regulated business in India. Stringent conditions meant that very few licenses were issued each year and incumbents usually enjoyed extraordinary profits merely by existing.
“(Until now), AMCs would launch the same set of products under different names. There was no attempt to think outside the box," said Deepak Shenoy, founder and chief executive officer, Capital Mind, which has applied for a mutual fund license.
“The old established players (have) leveraged their associated banks in order to grow assets and are wedded to that labour intensive model. But now, you can reach investors online through technology directly. You do not need a vast army of distributors or relationship managers," Shenoy added.
What remains to be seen is whether all of this is merely big talk or will the ground beneath India’s growing club of investors indeed shift towards a positive, consumer-friendly direction in the near future.
Shadow on active funds
S &P Dow Jones Indices issues a report each year documenting the performance of actively managed mutual funds in India. According to the SPIVA Report, for the first half of 2021 (ending in June 2021), market indices beat 86% of large cap funds, 57% of mid-/small-cap and 54% of equity-linked savings scheme or ELSS funds.
Over a 5-year period, the figures are rather similar at 83%, 70% and 76%, respectively. Despite questions about the effectiveness of actively managed funds, the mutual fund investor base in India has largely ignored the data. Part of the reason for the collective shrug is the ecosystem through which the mutual fund industry operates.
AMCs paid commissions to distributors, who, in turn, serviced investors. Commissions were far higher in the actively managed fund category than in index funds or exchange-traded funds (ETFs). It was in no one’s interest to reduce the cost and commissions associated with fund management.
However in 2015, the Employees’ Provident Fund Organisation (EPFO) announced that it would be investing 10% of its incremental collections in ETFs. This was subsequently raised to 15%. The EPFO decision added heft to a hitherto marginal segment of the mutual fund industry and offered the benefits of scale to mutual funds who did want to focus on the segment.
Meanwhile, another revolution was brewing that challenged the ecosystem of ‘regular’ or commission-bearing mutual funds that are distributed largely by big banks. This was the rise of fintechs registered as investment advisors (popularly known as RIAs).
These fintechs offered investors the ability to invest in direct (commission-free) plans of mutual funds without any extra charges and spent a considerable part of their marketing budgets highlighting the effects of commissions and cost on the returns that investors got. As a result of these shifts, the share of passive mutual funds had already started rising steadily—from 1.1% of the total AUM in January 2015 to 10% in August 2021.
Bharat Bond experiment
In December 2019, Radhika Gupta, chief executive officer of Edelweiss Mutual Fund and one of the industry’s largest social media influencers, was engaged in a frenzy of activity. Her small AMC, Edelweiss Asset Management Company, had received a mandate from the government to manage India’s first passive debt mutual fund.
Conventional wisdom until then insisted that while passive investing could work in large liquid equity markets, debt needed the steadying hand of a fund manager. The lack of liquidity would mean mutual funds at times won’t be able to meet large redemptions. However, within a month or so, Gupta’s team had pulled off the unthinkable. The first set of Bharat Bond ETFs were born and had collected over ₹12,000 crore. Passive investing had come to debt mutual funds.
The Bharat Bond launch was followed by a series of copycat products from the rest of the industry. The success also threw open the door to product innovation, a strategy that the new entrants are banking on now. “With the shake-up of the industry that is now underway, I expect a lot more products to emerge," said Capital Mind’s Shenoy. “The recent permission to set up Silver ETFs is a case in point. We can have ETFs tracking several other commodities."
Even as the new entrants shake-up an entrenched ecosystem, the industry itself has been affected by a Sebi initiative launched in May 2021 to set up a centralized platform to buy and sell mutual funds. The platform called MF Central would also handle service requests. It would be funded and run by registrar and transfer agents (RTAs) and potentially threatens the business of India’s vast army of distributors, who are an integral part of the traditional MF ecosystem.
MF Central can also level the playing field between established and new AMCs, reducing the need to set up extensive customer service and operations teams. “With initiatives like MF Central, costs will fall across the board on routine services issues like nomination and transmission and this can level the playing field between the incumbents, who already have large service capabilities, and the new entrants," said Dhirendra Kumar, chief executive officer, Value Research, a mutual fund data and analytics portal.
However, Kumar, is a sceptic and does not believe that a big shift is underway. “I do not think that the new fintech players will take away a significant market share from the incumbents or spark a race to the bottom in terms of fees and expenses. Brands still hold a lot of power in India and some of the existing players have powerful brands. Rather, the new entrants are likely to expand the market and bring in small investors who are not currently well serviced by the distribution ecosystem," he said.
The emerging challenges
Srikanth Meenakshi, founder, Priminvestor.in, is also cautious about the extent to which the current industry players can be challenged. “It is not easy to create competitive advantage in the mutual fund industry on product or strategy. When one fund house launches a successful model, it quickly gets replicated. Take the PPFAS Flexicap model of partially investing in US stocks. Several other fund houses are also doing it. Similarly, take the Motilal NASDAQ ETF. Several fund houses have launched their own versions."
It is true that the surge of new players could spur innovation, akin to what ensued after the launch of the Bharat Bond ETF, Meenakshi said. “But the room for this is limited because these strategies are easily replicated. A lot of the new players are simply intermediaries—distributors or fintechs—who (now) want to do backward integration. This is a fundamental tenet of business thinking—if you are selling someone else’s products, at the back of your mind, you consider launching your own," he added.
There’s also likely to be a short-term negative fallout due to the current wave of disruption. Clutter and product confusion will rise in an industry that already has a vast array of products.
In October 2017, Sebi came out with a wide-ranging circular on the classification of schemes. The market regulator created 26 categories of open-ended mutual funds and restricted mutual fund houses to just one scheme per category for most of them. One of the regulator’s aims in coming out with this circular was to reduce complexity and duplication in the mutual fund world.
However, as with many other laws in India, the effort came to naught. The number of open-ended mutual fund schemes ballooned from 828 in October 2017 to 1,056 in August 2021, according to data from the Association of Mutual Funds in India (AMFI). The entry of new houses has only added to this gargantuan pile.
“The sheer number of schemes and their ever-growing quantity is an issue. Today, AMCs can launch any number of close-ended or thematic schemes. If these are sold based on recent performance, it can result in a poor experience for an investor," said Value Research’s Kumar.
However, the new entrants feel that they have a better handle on the pulse of India’s millennials who are going to be earning and investing money over the next few decades. According to Navi’s Jain, the growth in the mutual fund investor base will come from young people (18-35 age bracket).
“These investors are looking for simplicity since they are used to apps like Amazon, Flipkart, Uber and Swiggy. They expect a similar experience from MFs—simplicity of product and technology. Today, there are around 1,700 funds—you need a recommendation engine to help one choose what’s right for them," he said.
Jain also acknowledged that cost was an important differentiator for his asset management company.
“Take today’s young investors. They are used to comparing prices on multiple apps. Why wouldn’t they do so with mutual funds?" he added.
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