The shift in investor preference towards mutual funds has been facilitated by fiscal incentives, increasing returns from debt mutual fund investments due to the secular decline in interest rates, availability of higher choices to investors, the gradual change in risk profile of the investors as well as the attempts by the Association of Mutual Funds of India (AMFI) to put in place an appropriate regulatory environment. Crisil Fund Services (CFS) expects mutual funds to continue to attract an increased proportion of the wallet share of investors going forward.
Genesis Of The Indian Mutual Fund Industry
The mutual fund industry has seen various phases in India and has evolved over the last 10 years in a big way. It started in India in 1963 with the setting up of Unit Trust of India. Its total Assets under Management (AUM) have reached to a level of Rs 67 billion by the end of 1988. In 1987, some public sector banks and insurance companies started their own mutual funds and kicked off the second phase in the mutual fund industry. SBI Mutual Fund, LIC Mutual Fund etc. were few among them.
The mutual fund industry registered a major milestone in 1993 with the beginning of first private sector mutual fund. The erstwhile Kothari Pioneer Mutual Fund (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993. After that several mutual funds have started in India, including many international players. The industry has also seen a spate of mergers and acquisitions with the acquisition of the schemes of Sun F&C by Principal and Zurich by HDFC AMC.
The most recent phase in the evolution of the industry started when Unit Trust of India (UTI) was bifurcated into two separate entities. The first one is the specified undertaking of UTI and covers mainly the AUM of US-64 (the first mutual fund scheme in India) and other assured return schemes. The second is the UTI Mutual Fund, which manages about 40 schemes and AUM worth Rs 190.59 billion as of December 31, 2003.
Sharp Growth In Assets Under Management
While the Indian mutual fund industry has grown in size by about 200 per cent from March, 1993 (Rs 470 billion) to December, 2003 (Rs 1400 billion) in terms of AUM, the AUM of the sector excluding UTI has grown eightfold from Rs.152 billion in March 1999 to Rs1203 billion as at December 2003. Though India is a minor player in the global mutual fund industry, its AUM as a proportion of the global AUM has steadily increased and has doubled over its levels in 1999 (See Assets Under Management).
Debt-oriented Schemes Constitute 80% Of The AUM In India
All the mutual funds schemes, offered by various fund houses, can be classified broadly in six investment categories, which is based on the investment objective of these schemes. These categories are: Income, Growth, Balanced, Liquid / Money Market, Gilt and Equity Linked Saving Schemes (ELSS). The mutual funds assets (Rs.1401 bn) are distributed in above categories in the following manner as on December 31, 2003:
Only about 20 per cent of the funds are allocated to equity categories and rest is invested in debt categories. That is mainly because of risk-averse behaviour of Indian investors as well as the high returns offered by debt mutual funds till FY 2002-03.
If we compare this with distribution of mutual funds in various investment categories in global markets then trend is just reverse of Indian mutual fund industry allocation with a much larger contribution towards equity schemes, as shown in the chart below:
While the mutual fund industry has shown significant growth recently in India, they are still a relatively nascent concept to the retail Indian investor.
The later has been largely focusing more on instruments like NSC (National Savings Certificate), PPF (Public Provident Fund), etc or Insurance Schemes for the following reasons:
To save on taxes by investing in the above instruments because of tax exemptions associated with them
No credit risk
Unaware of the complete risk - return paradigm in mutual funds
Equity and debt markets have been very volatile in last few years. The growth in the Indian mutual fund industry has also been affected by the negative sentiments in the equity markets post the technology boom of 1999 and 2000 and some of the scams which had affected it in the past.
Further on account of the lack of awareness about the risk-return paradigm in mutual funds, a large proportion investors were expecting fixed returns from mutual funds and their confidence was shaken because of negative returns produced by mutual funds (mainly equity funds) when markets have declined.
CFS has analysed the performance (Return & Risk) demonstrated by various scheme categories over the last five years.
In doing so, the returns are arrived at after calculating average of daily returns for each period whereas risk levels are standard deviations of the annual daily return series.
The analysis of returns (See MF Return Trends) reflects the high volatility in the last five years. Equity funds have outperformed the index in periods of boom in equity markets but have underperformed it in bear periods.
These funds gave excellent average returns of 82.39 per cent in the one-year period ending January 2004 as compared to the Sensex return of 67.37 per cent.
Debt funds have registered a strong performance in the first four years on account of falling interest rates. But this excellent performance by debt funds has slowed down recently, largely because of uncertainty on interest rate trends.
CFS analysis on volatility trends indicates that risk taken by equity funds has reduced over last two years whereas debt funds are showing rising risk in the same period because of the uncertainties in interest rate movements.
CFS believes that going forward, while competition in the Indian mutual fund industry will intensify, fund managers would need to continuously innovate and deliver relevant products to attract investors. As the Indian markets and investors mature, financial advice, product diversification and multi distribution channels would become critical factors for long-term success.
The market regulator, Securities and Exchange Board of India, has already brought about sweeping changes regarding disclosure norms for the industry. As the regulatory framework moves towards a platform of greater transparency, in a move to safeguard the integrity and viability of this industry, investors would increasingly have a greater degree of comfort.
In CFS opinion it is expected that that with increasing maturity of the Indian investors, more and more investors would be drawn to the mutual fund sector and thus auguring positive growth rates for the industry.
Management of pension funds offers new opportunities for business expansion for asset management companies. The yields under pension and provident fund can be raised substantially through professional fund management. Globally, mutual funds are managing money for pension funds to help them improve yields by allowing access to a wider range of investment avenues. In the Indian context also, mutual funds can similarly help provident and pension funds.
Increasing investor awareness can play a very important role in propelling the growth of the Indian mutual fund industry. Investors need to be educated on the common fallacy of comparing returns of debt-oriented fixed income mutual funds and fixed income products of small savings schemes without considering associated risks.
While the AUM of the Indian mutual fund industry as a percentage of GDP has increased from 3 per cent in 1999 to 4 per cent in 2002, it still pales in comparison to size of the sector other countries both in the developed and developing world (See Global Mutual Fund Industry).
However, one must look at this more from the view of the huge growth potential available for the Indian mutual fund industry even if it is able to reach the 20 per cent levels of a country like Brazil leave alone the USA or Hong Kong. Indian Mutual Funds will thrive in the financial landscape if the Indian investor is better informed about the benefits of investment in mutual funds as compared to alternative investment avenues. Once this is done, this industry would be on course to expand and meet the demands of the broad spectrum of investors who would like to experiment with new investment opportunities.
This would pave the way for the mutual fund industry to become one the primary investment vehicle for the retail investors. Much would also depend on the way the expectations are created and fulfilled by the fund industry.