Research Papers

How to increase penetration of Mutual funds

Economic reform process of 1991 had a great impact on the financial system of the country
leading to the overall development of the Indian economy. Today, India’s financial system is
considered to be sound and stable as compared to many other Asian countries where the
financial market is facing many crises. During last one decade or so, role of Indian mutual
funds industry as a significant financial service in financial market has really been noteworthy.
The biggest problem of the mutual fund industry is that the funds prefer bulk investors over retail
investors and, hence, the distribution mechanism remains underdeveloped. The time has come to
undertake drastic and speedy action on this and a host of other issues. This paper aims to study
how to increase the penetration of mutual fund.

Introduction
The growth of Mutual funds in any economy is an indicator of the development of financial
sector and the extent to which investors have faith in the regulatory environment. Mutual fund
industry in India began with the establishment of Unit Trust of India, in 1963. Between 1987
and 1993 other entities belonging to the public sector were permitted to offer mutual funds. From
1993 onwards, private sector organizations were permitted to enter the market and the first
mutual fund regulations were promulgated, which were subsequently replaced by the SEBI
(Mutual Fund) Regulations of 1996. These private sector organizations comprised predominantly
Indian and foreign joint ventures as well as purely Indian firms. In the last decade the mutual
fund industry has been one of the fastest growing industries in the financial services sector, with
the assets under management growing at a CAGR Of 13% between 1993 and 2005.

Since private players were allowed in 1993, the Indian Mutual fund industry has witnessed a sea
change in the way it operates, in the regulatory and investor attitude towards Mutual fund
products. From a single player in 1987 today there are 29 mutual funds offering as many as 477
schemes. The total assets under management have risen to Rs 417 as on mar 2009. However, the
accolades regarding the growth of the MF industry should be reserved until this growth is
analyzed taking the MF industry in other developed countries in consideration. Here are certain
statistics that reflect that Indian Mutual fund industry still has a long way to go when compared
to global standards.
Some of the AMCs operating currently are

Name of the AMC Nature of ownership

Alliance Capital Asset Management (I) Private Limited Private foreign

Birla Sun Life Asset Management Company Limited Private Indian

Bank of Baroda Asset Management Company Limited Banks

Bank of India Asset Management Company Limited Banks

Can bank Investment Management Services Limited Banks

Cholamandalam Cazenove Asset Management Company Limited Private foreign

Dundee Asset Management Company Limited Private foreign

DSP Merrill Lynch Asset Management Company Limited Private foreign

Escorts Asset Management Limited Private Indian

First India Asset Management Limited Private Indian

GIC Asset Management Company Limited Institutions

IDBI Investment Management Company Limited Institutions

Indfund Management Limited Banks

ING Investment Asset Management Company Private Limited Private foreign

J M Capital Management Limited Private Indian

Jardine Fleming (I) Asset Management Limited Private foreign

Kotak Mahindra Asset Management Company Limited Private Indian

Kothari Pioneer Asset Management Company Limited Private Indian

Jeevan Bima Sahayog Asset Management Company Limited Institutions

Morgan Stanley Asset Management Company Private Limited Private foreign

Punjab National Bank Asset Management Company Limited Banks

Reliance Capital Asset Management Company Limited Private Indian

State Bank of India Funds Management Limited Banks

Shriram Asset Management Company Limited Private Indian

Sun F and C Asset Management (I) Private Limited Private foreign

Sundaram Newton Asset Management Company Limited Private foreign

Tata Asset Management Company Limited Private Indian

Credit Capital Asset Management Company Limited Private Indian

Templeton Asset Management (India) Private Limited Private foreign

Unit Trust of India Institutions

Zurich Asset Management Company (I) Limited Private foreign

Recent trends in mutual fund industry
The most important trend in the mutual fund industry is the aggressive expansion of the foreign
owned mutual fund companies and the decline of the companies floated by nationalized banks
and smaller private sector players.

Many nationalized banks got into the mutual fund business in the early nineties and got off to a
good start due to the stock market boom prevailing then. These banks did not really understand
the mutual fund business and they just viewed it as another kind of banking activity. Few hired
specialized staff and generally chose to transfer staff from the parent organizations. The
performance of most of the schemes floated by these funds was not good. Some schemes had
offered guaranteed returns and their parent organizations had to bail out these AMCs by paying
large amounts of money as the difference between the guaranteed and actual returns. The service
levels were also very bad. Most of these AMCs have not been able to retain staff, float new
schemes etc. and it is doubtful whether, barring a few exceptions, they have serious plans of
continuing the activity in a major way.

The experience of some of the AMCs floated by private sector Indian companies was also very
similar. They quickly realized that the AMC business is a business, which makes money in the
long term and requires deep-pocketed support in the intermediate years. Some have sold out to
foreign owned companies, some have merged with others and there is general restructuring going
on.

They can be credited with introducing many new practices such as new product innovation,
sharp improvement in service standards and disclosure, usage of technology, broker education
and support etc. In fact, they have forced the industry to upgrade itself and service levels of
organizations like UTI have improved dramatically in the last few years in response to the
competition provided by these.

Performance of Mutual Funds in India

Let us start the discussion of the performance of mutual funds in India from the day the concept
of mutual fund took birth in India. The year was 1963. Unit Trust of India invited investors or
rather to those who believed in savings, to park their money in UTI Mutual Fund. The
performance of mutual funds in India in the initial phase was not even closer to satisfactory
level. People rarely understood, and of course investing was out of question. But yes, some 24
million shareholders were accustomed with guaranteed high returns by the beginning of
liberalization of the industry in 1992. This good record of UTI became marketing tool for new
entrants. The expectations of investors touched the sky in profitability factor. However, people
were miles away from the preparedness of risks factor after the liberalization.

The Assets under Management of UTI was Rs. 67bn. by the end of 1987. Let me concentrate
about the performance of mutual funds in India through figures. From Rs. 67bn. the Assets
Under Management rose to Rs. 470 bn. in March 1993 and the figure had a nine times higher
performance by mar 2008. It rose as high as Rs. 4173bn. The net asset value (NAV) of mutual
funds in India declined when stock prices started falling in the year 1992. Those days, the market
regulations did not allow portfolio shifts into alternative investments. There was rather no choice
apart from holding the cash or to further continue investing in shares. One more thing to be
noted, since only closed-end funds were floated in the market, the investors disinvested by
selling at a loss in the secondary market.

Current Scenario
Since private players were allowed in 1993, the Indian Mutual fund industry has witnessed a sea
change in the way it operates, in the regulatory and investor attitude towards Mutual fund
products. From a single player in 1987 today there are 29 mutual funds offering as many as 477
schemes. The total assets under management have risen to Rs 4173 bns. However, the accolades
regarding the growth of the MF industry should be reserved until this growth is analyzed taking
the MF industry in other developed countries in consideration. Here are certain statistics that
reflect that Indian Mutual fund industry still has a long way to go when compared to global
standards:

 AUM as a Percentage of GDP: In most of the developed countries the total assets under
management ranges from 30% -60% of the GDP. Total assets under management are
only 8% of the GDP in case of India.

 Penetration of Mutual funds: In India it is estimated that 6.7% of the households

mutual funds. This figure is close to 50% in case of the US and 17% in case of UK.
Mutual funds account for only 0.73% of total financial assets in India (11% of bank
deposits). AUM for Mutual funds had exceeded the bank deposits in US in as early as
1998.

These are only some of the statistics that show that the Indian mutual funds industry is still in its
infancy. It is important to study the present industry scenario to gain a better understanding of
the impediments to the growth of the industry.

 Lack of Investor Awareness: Retail investors had a wrong notion about mutual funds as
an investment avenue. The benefits of risk diversification, professional management and
ease of administration involved while investing in mutual funds are not clearly
understood. Knowledge of financial products is ingrained in school and college
curriculum in countries like UK, US and France.

 Investor Risk Appetite: Equity funds account for 30% of the total AUM in India. This
figure is more than 50% in most developed countries. Frequent stock market scams and
the bust of tech sector specific MFs have contributed to this apprehension. The growth in
mutual funds has come through the growth in investments in short term instrument like
Money Market Mutual Funds which account for 40% of AUM.
 Higher Returns of Alternative Debt Instruments: Government guaranteed schemes
provide risk free returns at competitive rates of returns. This is why mutual funds have
difficulty competing retail business.

 Concentration of Corporate Investors: Mutual funds have become overly attractive to

corporate investors because of higher returns than bank deposits and ability to distribute
capital gains tax. Corporate investors account for 57% of the AUM (by value). Though
the turnover rates have increased the average fund in management has grown by only
25% in the past 4 years. It is clear that the lack of growth in funds under management in
India is because of the absence of long term investors. Corporate investors take profits
frequently resulting in destruction in the compound growth in funds under management.
Distributors are forced to pass on more commissions to companies, while fund companies
are compelled to offer funds with wafer thin margins. Retail investors lose out in the
sense that they continue to pay higher expenses.

 Distribution: One of the major factors impacting the growth of mutual fund industry is
the absence of any regulation in distribution of mutual funds. Mutual fund investors need
distributors who are able to inform them about the efficacy of distribution product for a
particular risk profile and stage in life cycle. Lack of distributor awareness and the
absence of any disclosures from distributors make miss selling of MF products
commonplace. Also penetration in rural areas is a problem. Only 3% of rural households
own mutual funds. For mutual funds to set up a distribution network in these centers can
be very expensive.
Future Expectations from Indian Mutual Fund Industry
Taking into consideration the above comparison and the current situation prevailing in the capital
markets, the realistic expectations from the Indian Mutual fund Industry could be:

 Increased Penetration: With the proposed opening up of pension funds to the private
sector we can expect the penetration levels of MFs to increase in the next few years.
Because of their experience in managing MFs the AMCs will play an important role in
the management of pension funds.

 Increased Emphasis on Retail Investors through Supply Chain Innovations: Retail

investments less than Rs 10,000 are unprofitable for AMCs. However, certain supply
chain innovations and investments in retail infrastructure would lead to increased
emphasis on retail investors. Some of the possible innovations can be the use of “straight-
through processing," an industry buzz phrase for automating mutual fund transactions so
that the entire process-from placing a trade to final settlement-is fast, relatively seamless
and less subject to manipulation. Straightforward concept, straight-through processing
requires substantial integration and cooperation among members of the mutual fund
supply chain. Using IT, members of the mutual fund supply chain can improve
efficiency, manage risk and improve regulatory compliance-all critical moves for
maintaining investor confidence in mutual funds. As urban markets reach a peak mutual
funds would target second rung cities and smaller towns to increase their investor base.

 Diverse Range of Products: In order to make MFs more acceptable to the retail investor
mutual fund industry has to mature to offering comprehensive life cycle financial
planning and not products alone. These would include products catering to specific life
cycle needs like buying a house, funding college admission etc. With increase in investor
awareness many new products would be introduced. Some of them are listed here:
derivative based MFs (though a cap on derivative exposure for a sponsor currently
exists), commodities and real estate MFs (appropriate regulation from SEBI in case of
real estate pending ), feeder funds, funds of funds, capital protected funds, etc.

 Increase in the need for financial advice: As the affluence of Indians increases and the
range of financial products available to meet people’s needs expands – mortgages,
deposits, life products, defined contribution pensions, mutual funds, etc – the need for
financial advice will increase. Mutual fund distribution will become geared towards
providing sound financial advice according to investor’s risk profile and stage in life
cycle.
Recommendations
With penetration levels at close to 6% great scope exists for the growth of mutual funds in India.
Mutual funds have to compete with bank deposits and government securities for a share of
consumer savings. This requires the regulator and the AMC to increase the credibility of MFs
and develop a trust among the average retail investors. I recommend the following steps on part
of SEBI and AMCs:

Steps to be taken by SEBI

Increase Accountability among Different Players

 Give the board of trustees the right to choose a fund manager of their own choice. This
will make them more accountable and aware as to what the AMC is doing.

 Benchmark the performance of funds with peers as well as with specific indices.

 Restriction on who can be appointed as sub-brokers.

 Implementation of international accounting principles across the mutual fund industry

will help promote fairness and stability of the sector.

Develop of AMFI an SRO (Self Regulatory Organization)

This will reduce the regulatory burden on SEBI. Most of the developed countries have SROs that
publish monthly disclosures of important MF related figures, and enforce a model code of
conduct. Though similar experiments have been unsuccessful in Western countries I propose a
slightly modified role of AMFI:

 AMFI will work towards increasing investor awareness through the publication of
documents, organizing seminars etc.

 Also AMFI serve as a regulator of distributors because mutual funds complain of poor
distributor regulation as the biggest challenge to the industry.

Regulating Corporate Investments

Regulatory requirements that require mutual funds to segregate large and small investors. This
would enable retail investors to pay expenses that are relevant to their investments and turnover
rates.
Investor Education Programs

As the principal regulator of financial services in the country SEBI should invest in programs
that give investor knowledge about financial products in the country. Investors should be able to
make informed decisions after knowing how MFs can be used for financial planning. This could
be done in conjunction with AMCs, AMFI and other participants in the financial sector.

Steps to be taken by AMCs

 Make mutual fund offer documents more comprehensible by making disclosures more
simple and relevant, and fund structure more distinctive to the common people.

 Make disclosures regarding the MF expenses more transparent especially distributor

expenses which form a major chunk of entry loads.

 Make fund managers accountable to unit holders. This can be done by organizing Annual
General Meetings of unit holders where performance of the fund would be reviewed.

Conclusion
The comparison of the Indian MF industry with respect to global standards showed that India has
a lot of catching up to do in terms of penetration, the diversity of products, and the risk
mitigation techniques used. However, the attitude of the regulator towards investor protection
and governance of mutual funds was found to be very close to global standards. The Indian MF
industry is possibly at a point of inflection on the verge of explosive growth. The factors that
point towards this are the existence of robust capital markets and the presence of an impartial
regulator. In order to reap the benefits of this growth, the mutual fund industry has to introduce
changes at the rate of knots. These changes include introduction of newer products,
improvements in MF distribution and better governance of mutual funds. The MF regulator
(SEBI) should increase the accountability of all major players including the AMCs, distributors
and brokers to build trust among retail investors.
References

Journals

 Vidyasagar University Journal of Commerce Vol. 12, March 2007

Online Resources

 www.sebi.gov.in

 www.amfiindia.com

 www.thehindubusinessline.com