Equity funds continue to remain the preferred asset class for retail investors. We also witnessed the emergence of balanced funds, where many risk averse or first-time equity investors decided to make investments.
Traditionally, Indian equity markets have been reliant to a large extent on global flows. Any significant inflows or outflows by foreign institutional investors (FIIs) caused our markets to react. Last year was a watershed year in that respect; the great Indian investment story took root as domestic investors latched onto equity mutual funds.
Record domestic flows
Domestic flows in 2017 surpassed all expectations as investors came in a big way into mutual funds. Demonetisation, which was announced towards the end of 2016, helped channel investor interest towards mutual funds over traditional investment avenues like real estate and gold.
Equity funds got the additional benefit of buoyant equity markets, which resulted in investors increasing allocations towards equities. Equity mutual funds now constitute 40.8% of the overall industry’s assets, up from 31.9% a year ago. Retail investors have invested heavily in equity and balanced funds. The mutual fund industry assets under management (AUM) crossed the `20-lakh crore mark in 2017 and has more than doubled since 2014. Since the demonetisation announcement the overall industry AUM is up 42% and continues to grow at a healthy pace. Systematic Investment Plan (SIPs) were also a key part of these flows as the SIP numbers rose month on month and stand at `6,500 crore. Fund flows have been strong since 2014, after a fairly long lull period. While 2016 did see a minor dip in flows, it was towards the end of 2016 that was the inflection point for fund flows. Right through 2017 we witnessed strong flows across fund categories.
Equity funds most preferred
Equity funds continue to remain the preferred asset class for retail investors. We also witnessed the emergence of balanced funds, where many risk averse or first-time equity investors decided to make investments. Balanced funds received significant flows over the last few years and currently some of the industry’s largest funds are now balanced funds. Large-cap funds continue to be the core holding in investor portfolios and tend to receive the largest absolute flows. But in 2017, several marque flexicap funds found favour with investors (especially because of their small/mid cap exposure outperforming. This resulted in flexicap funds receiving the largest absolute inflows. Small/mid cap funds have received disproportionate flows over the years and are growing to be a larger part of investor portfolios. The year 2017 was no different as small/mid cap funds continued to witness robust flows, despite several stocks heading into the expensive valuation zone. Fund managers, on their part, looked to pare small/mid cap exposure where suitable and use a stock specific approach while picking small/mid cap names.
Equity-linked saving schemes (ELSS) while constituting a smaller proportion of flows, have also seen a healthy increase in inflows, as investors are increasingly choosing ELSS as a tax saving tool over traditional fixed income options. The introduction of Long Term Capital Gains Tax (LTCG) and resulting market volatility were expected to dampen investor sentiment, but there doesn’t seem to be any signs of this happening yet. This seems to suggest early signs of investor maturity whereby instead of redeeming, investors are looking to use market dips to increase equity exposure. We believe equity mutual funds, despite the introduction of 10% LTCG tax, still represent the best investment opportunities for long term investing.
The writer is director of Manager Research, Morningstar Investment Adviser (India). Extracted from Morningstar report—Indian Equities Sector Wrap