The year 2009 had witnessed a boom for mutual funds as banks, faced with the poor loan scenario post the economic slowdown, invested their surplus capital in income and liquid schemes that offered tax benefits, higher returns, liquidity as well as relative insulation from market volatility. The schemes were widely accepted, as is witnessed by the fact that about 66% of the industry’s corpus lies in ultra liquid and liquid funds, as per the December figures released by the Association of Mutual Funds of India. The liquid plus schemes in particular, were highly popular. These had been introduced in 2007, in response to the budget increase in dividend distribution tax (DDT) for corporates from 14.03% to 28.03% in liquid funds.

However, these schemes are now rapidly losing their attractiveness. Following a record high of Rs.807,556 crore in November, the average monthly Asset Under Management (AUM) of top fund houses in India dropped for two successive months to Rs 7,94,486 crore in December and down again to Rs 7,61,632 crore in January this year. Inflows dropped due to the banks’ capital adequacy requirements in December and the impact of RBI’s October 2009 review of the monetary policy directing banks to cap their investments in MFs. The sharpest cut has been Sebi’s notification last week, according to which debt and money market instruments with maturity of over 91 days will be subject to mark-to-market norms from July 1.

In the near future, some more measures seem to be in the pipeline. There have been musings about the government taking the tax benefits away from fixed income funds, as also focusing on increasing the retail reach of the funds.

SEBI’s move is likely to change the pattern of institutional investments into liquid-plus schemes – the probable volatility in these schemes, however nominal, will have to be factored in by a savvy treasury manager. In addition, the expected pick-up in credit off-take would affect inflow into mutual funds, as banks lend money to borrowers at higher rates.

These are interesting times for the mutual fund industry. Before the new valuation guideline comes into effect on July 1, the MF industry will need to have evolved further. Keeping volatility in mind, fund managers in these emerging times require to be sharp witted and quick to respond.

Clearly, the texture of short-end money market funds will have to evolve. Institutional money would be difficult to come by in a relatively plain vanilla commoditized liquid/ liquid plus scheme. The challenge is to create products that are relevant to evolving regulatory conditions and changing customer requirements. As standardization is brought into the industry and independent agencies monitor the methodology of valuing debt instruments, old products need to be tweaked to fit the new regulations, while new and innovative products need to be brought into the system.

The financial industry, meanwhile, can benefit from the innovative minds that are gearing up to make the fund industry more competitive and efficient.

Market expansion is the order of the day and for this, innovation, both in products and schemes, is key. The need is to strengthen distribution systems and retail penetration. Distribution now needs to get energized and service-oriented, with targeted products that cater to diverse end-customers such as temple and charitable trusts as well as individual customers.

There is likely to be a wave of structured products that would start catering to the emerging B2B segment. As institutional customers get more evolved and the options in the conventional MF space cramp up, there would be an impetus to adapt international products for the Indian markets.

Interest in structured products seems to be reviving, more than a year after the Lehman Bros debacle – taking, of course, into consideration the recent hard-bought wisdom that the more complicated the product, the less transparent the risks. According to research conducted by Barclays Wealth, 69 per cent of advisers considered that structured products had become more attractive to them in the past year. In India too, new structured products are finding more takers, marking the increasing confidence in such products

Along with the challenges to change and adapt, is the increasing potential waiting to be tapped, as the world of potential investors grows by the day. Client focus and forward thinking to fit new aspirations and a new generation of retail investors with increased levels of awareness could mark the emerging arenas in which the mutual fund business will have play.

Disclaimer: All views expressed in this blog are my personal and in no way express or implied, of that of the company I work with, or have worked with in the past.

In India, it’s the institutional investors who dominate AUMs, particularly in the fixed income space. Apathy in fixed income products when there are enough guaranteed return products around, inadequately compensated retail distribution channels and a drive to chase large tickets in fixed income to buttress their AUM are some of the prime reasons for indifferent retail patronage.

Improving retail penetration requires fund houses to expend significant efforts and costs, while access to institutions ready with funds is relatively easy in terms of the effort reward relationship.

Why is this so? Here, size does matter. Let’s take an example. If there is a liquid fund of 1,000 crores with 100 investors vis-à-vis 750 crores with 1,500 investors, guess which get’s noticed up by distributors and the media alike?

The 1,000 crore fund. Hence, the rush for ramping up size and it’s consequences thereof.

This skewed distribution is a cause of concern because massive redemptions by institutional investors in times of crisis or otherwise influence the decisions of the fund and are likely to negatively impact the interests of small investors. Since institutions help swell the AUM, fund houses find little merit in aggressively pursuing the retail investor. But this means that the retail investor is missing out on a beneficial investment product. Also, as most corporate investments flow into debt schemes, and the flow is easy, there are few incentives for product innovations.

I have always maintained that there has to be an equal focus on number of investors. The right way to assess an AMC’s schemes is the weighted average result of AUM and number of investors.

Apparently, SEBI is in sync with the same. There have been recent reports about SEBI relooking the ‘20-25’ rule ie a rule which requires a scheme to have a minimum of 20 investors, with a single investor not owning more than 25% of assets. It has often been observed that this rule is usually not followed in spirit with a few dominant investors ruling the roost, specially in a scheme like an FMP.

To put a check on this practice SEBI is planning to increase the minimum numbers of investors required in a mutual fund scheme and bring down the maximum holding by a single investor from the current level of 25.

Mandatorily ask AMCs to disclose their unitholder status per fund and then let the investors decide whether they would still like to invest or not.

While this is welcome, I think the better route would be to require fund houses to disclose the details of their AUM composition at the end of every month. Apart from disclosing the total AUMs (that is the way it is currently done), mutual funds may have to specify the pattern of investor holding among other things. Many retail investors choose a scheme based on its AUM – their perception is larger the AUM, the better is the scheme. But these are not necessarily correlated; also the AUM figure by itself does not give the investor an idea of a scheme’s client base.

I would like to believe that once there is more transparency on this count, the impetus will be on fund houses to get more and more new investors. As I have mentioned elsewhere in this blog, retail penetration is the core necessity around which there will be many more inventions in the AMC space.

Disclaimer: All views expressed in this blog are my personal and in no way express or implied, of that of the company I work with, or have worked with in the past.

If one were to go by the spirit of recent SEBI guidelines, this new avenue for conducting mutual fund transactions empowers the investor with more choice.

Let’s look at some of the advantages for the investor :mutual fund

• It opens up a convenient investment option for the investor. It will now be possible for investors to go to their nearby broker and conduct a mutual fund transaction, just like they do for their share transactions
• The guidelines for investing are exactly the same, or that’s what it looks like. The cut off time for the NAV applicable will still be 3:00 pm – ie, a mutual fund “trade”/ investment executed by the stock broker before 3 pm gets the same days NAV
• Units get credited to the investor’s demat account. Bye bye lost account statements, hello convenience

There are some advantages from the AMCs perspective as well. These are :

• This is the first serious attempt at dematerializing mutual fund units, thereby leading to a saving of costs. No more couriering account statements (they cost over 15/- per transaction) leading to a whiff of fresh air – just a whiff, mind you – in terms of profitability for AMCs
• Broking houses are an additional distribution channel now. With this new rule if you have a stock terminal and you have a local sub-broker you can start selling mutual fund once you are AMFI certified
• This new point of sale will deepen mutual fund penetration and above all it allows AMCs to get into their fold a huge segment of KYC cleared people already dealing in stock markets

As with any new regulation, there will be an adjustment process with this one too and it will be some time before we can fathom the actual change it has brought out. At the outset, investors will not immediately queue broking houses nor will AMCs immediately enroll a ready set of KYC cleared investors.

Some of the issues which need clarification are :

• The stock market investor and the Mutual Fund investor are two distinct species, given their risk appetite/ Why should a stock market investor, with his penchant for high risk, high returns invest in Mutual Funds?
• The million dollar question is – why should a stock broker, who makes a sizeable amount of money by churning his client’s portfolio, recommend a mutual fund which has an exit load component as well?
• There seems to be clarity that the current regulations go beyond ETFs – however, it needs to be spelt out more explicitly for all stakeholders concerned
• There is no clarity on the fees brokers would charge their clients and how these would affect distribution costs of AMCs

While the rule opens a new vista of potential investors, fund houses have the usual convincing to do. You still need to educate the investor about mutual funds and now also about the need to open a Demat account. Even with the seemingly easy target – stock market investors, AMCs will have to develop a different pitch to attract them, as the expectations of this tribe regarding returns and in terms of investment horizons are usually different.

This renewed attempt at market expansion through financial literacy would be intense, to say the least and would further drain the already meagre margins the AMCs enjoy.

Net net, it looks like existing mutual fund distributors need to have an additional service component up their sleeve – providing a demat account to their investors, if they don’t have one already.

For distributors who have a broking arm, the rule will have a little impact. Till the time they condition themselves to the immense possibilities of mutual fund investment dynamics.

Let me end with a small example. My father has historically been a FD/ NCD investor. The only equity he has is what his friends and yours truly pushed him to subscribe to in the good old share certificate days.

It was a Herculean task dematerializing those units – it has been a nightmare explaining to him why he needs to pay up small amounts like demat charges when he paid nothing for his share certificates.

Finally, I found a solution. I have asked him to sell off all his stocks and get into a Systematic Transfer plan in Mutual Fund schemes. All of us seem to be at peace now.

What I shudder to think of is the hundreds of thousands of people like my father, who were confused about stock marketing investing in the first place,  now get further confused by a bunch of eager beaver stock brokers and Mutual Fund distributors armed with the latest guidelines. There are thousands of people like him across all age groups who need to be handled with kid gloves.

Overall, I think SEBI’s new rule is a positive development – I also feel that is a little ahead of its time and one should not rush with deadlines to implement these.

As I have always said, people need to be comfortable, rather than convinced about investments. If pushed too aggressively, SEBI might confuse rather than clarify and thus alienate investors for quite some time to come.

Disclaimer: All views expressed in this blog are my personal and in no way express or implied, of that of the company I work with, or have worked with in the past.

The truth of the matter is, the guideline is there, and it has to be adhered to. What is important is how you adapt to it, which brings me to my objection to the word ‘impacted’. I don’t believe in the word ‘impacted’. A regulatory or any significant external change does not impact a business but forces it to re-look at business models and adapt and innovate.

The questions should be ‘how will revenue models be changed’ rather than ‘how will revenue models be impacted’, ‘how will customers and distributors adapt’ rather than ‘how will they be impacted’.

I believe that in every industry there comes an inflection point every few years, which in the short-term creates some uneasiness in the industry. The Indian mutual fund industry too has had its share of upheavals. And each time, the industry has shown its inherent strength by adapting and adopting those changes to move ahead with a faster than before momentum. In the late 90s, Sec 54EA/ EB of the IT Act was a huge contributor to the growth of assets of the mutual fund industry. Hundreds of crores of long-term money was pouring in, particularly in the Equity fund segment. By a stroke of the pen, the act was abolished in 1999-2000, if my memory serves me right, leaving the industry gasping. The subsequent dot com bust had a pincer like effect on the growth of the industry as equity monies really shrunk. But eventually the industry evolved, got into income funds and MIPs and a whole new world of products and opportunities was opened.

There could be another school of thought that could say that just because the industry is so malleable, should it be subject to regulatory upheavals every few years? The recent SEBI guidelines have prompted this school of thought into action. Only time will tell how the recent SEBI guidelines (find them on www.sebi.gov.in) will pan out. In the interim, this is yet another point of inflection for the mutual fund industry. So how exactly is the industry adapting to this change?

• With the commission structure undergoing a dramatic overhaul, there is very little incentive for a distributor with a conventional business model to sell mutual funds. I have noticed some interesting trends in how distributors are reacting.
  • Some distributors are looking at using mutual funds as a client acquisition exercise. All said and done, mutual fund schemes are one of the most “user friendly” financial avenues around. These new clients will then be sold a heavy dose of high margin products like life insurance and their like.
  • Some distributors have started segregating clients based on the revenue they earn from them. Most low revenue clients are being shifted towards an online investment management experience.
  • Quite a few distributors, however, are using this opportunity to hone and display their asset allocation skills. They are now re-emphasising the virtues of better asset allocation in pursuit of long-term goals. This segment, to my mind, is already charging or is all set to charge clients for their services.
  • In terms of national level distributors and banks, most of them have already designed effective online/ offline retail strategies and are looking forward to consolidate their AUMs in light of the current regulations.
  • SEBI’s decision is an opportunity for distributors to reposition themselves as financial advisors, to build trust among investors and initiate investor education. In the long-term it is going to be good for their business – an investor who trusts a distributor with his mutual fund investment is likely to trust him with other investment products too.
• Quality of service has become a key parameter now. I have always believed that people invest when they are comfortable, not convinced about an investment avenue. Quality of service is going to be a key parameter in determining the comfort level of future investors. Remember, if the investor is comfortable, the distributor could charge a fee for his services as well.
• Fund houses and distributors will have to innovate and rework their business models to make this new equation profitable. We have a lot of commoditized products, and with each new entrant, the proliferation of such products is only going to increase.

My sense is that innovations in product, customer service and technology are going to be the key drivers towards growth. Performance will soon be relegated to a secondary level, particularly in mark to market products. This will also ensure more long-term assets. Effective use of technology would also be able to drive down costs while increasing volumes simultaneously. Definitely an impact on the P&L in the short term, but for fund houses with the vision, strategy and gumption to take this challenge head on, there couldn’t be a better time.

Investors, for whose benefit, the decision has been taken too have some thinking and hard work to do. After all, negotiating a commission for a service requires one to understand and determine the quality of service. So while some sceptics ask whether the mutual fund industry is mature enough to handle this change, I think it is wiser to ask whether Indian investors are mature enough for this change.

Investors are being empowered, but can they handle it, are they awakened? It’s a wait and watch situation. It’s like when a child passes out of school and goes into college, he is suddenly free of many restrictions, no uniforms, no strict school rules etc. There is a new-found independence and freedom, but whether she/he is mature enough to handle this freedom responsibly is something parents have to wait and watch. You don’t stop your child from moving out of school and entering college because you aren’t sure of his/her maturity to handle change. If it is absent, it has to be gradually taught.

It is also a misnomer to think that investors will come flocking to the industry just because entry loads have been abolished. In fact, the role of the distributor becomes even more critical in the current context. With a plethora of investment avenues and terabytes of information available, there is a serious chance of the investor getting overwhelmed and erring in his investment decisions.

How will the entire fraternity shape up? It’s early days yet. The adjustment process is on and I think it will be another three to six months before we actually know whether investors are benefiting in a non-tangible way. My feeling is that by March, we will get a clearer idea of how the distributor-investor equation is working out. A change is usually challenging because it forces you out of a set order. It throws you into uncharted waters. But once the initial resistance falls through, a process of innovation and adaptation begins and things gradually fall into place. I believe that fund houses that will go beyond the traditional distribution models, will be able to substantially expand their investor base. The process is slow, but the one that will create stronger business models.

Changing guidelines and external shocks are not new to the financial product industry, especially mutual fund industry. Adaptability of this sector is phenomenal. There will always be a new product to sell or a better way to service clients. In the Indian mutual fund industry, there has not been a single year that the AUM has fallen dramatically. During the recent financial crisis, when equity collapsed, debt picked up and when debt started flattening, equity picked up.

Call me a hopeless romantic, or a man who’s seen the industry evolve over the years – I believe that these guidelines are building a bulwark for a robust and aggressive growth of the industry. We have already given the world a lot of things to learn in the AMC space – in the next five years, the world would be benchmarking us for all their initiatives.

Disclaimer: All views expressed in this blog are my personal and in no way express or implied, of that of the company I work with, or have worked with in the past.