We give you tips to choose mutual funds that have the best chance of giving decent returns next year.
The broad equity market indicator, the S&P BSE Sensex, fell around 5 per cent in November. Still, equity mutual funds received a net inflow of Rs 8,068 crore. Was this due to demonetisation, which made people look for alternatives to park cash? Or was this an indication of the changing behaviour of mutual fund investors, who now react to market dips in a much more mature manner and don't panic? Experts say though it is too early to know if demonetisation was behind the surge in inflows, the behaviour of investors is definitely changing.
"Retail investors have learnt from their experience. They now prefer investing for the long term with maturity. That is why we received inflows in November in spite of a correction," says Nilesh Shah, CEO and MD Kotak Mahindra Asset Management Company.
Others agree. "Investors have become mature. They don't resort to panic selling when the market falls," says Jimmy Patel, CEO, Quantum Asset Management Company.
In fact, they buy more during market falls, says Prateek Pant, Head of Products and Solutions, Sanctum Wealth Management. "We get a lot more calls during market dips. Investors don't rush to sell their holdings during corrections, which used to be the case earlier," he added.
Since April 2014, net inflows (people invested more than what they redeemed) in equity mutual funds have been positive in all months barring just two. Equity mutual funds received a net investment of Rs 1.72 lakh crore during this period.
The faith shown by investors in mutual funds was not entirely misplaced as most managed to do well and beat their benchmarks in spite of operating in a challenging market. And, 2016 was the year of debt funds. Almost all debt fund categories delivered double-digit returns as falling interest rates, accompanied by demonetisation, led to a rally in bond prices. The category of Debt: Gilt and Medium Term, highly sensitive to interest rates, was the best performer and delivered an average return of around 15 per cent (as on December 27, 2016). The other debt categories returned 10-13 per cent.
Equity mutual funds returned 4-5 per cent, though most were able to beat their benchmarks. In equities, small-cap funds outperformed the large- and mid-cap peers by delivering 5 per cent returns. Among sector and thematic funds, banking funds were the best performing with a return of 10 per cent.
Not only are investors staying put during downturns, they are also increasingly investing through systematic investments plans, or SIPs, considered one of the best ways of taking exposure to equity funds. A SIP ensures that the investor doesn't have to time the market. It also averages out costs. "A lot of money coming into mutual funds is through the SIP route. SIP folios have crossed the one crore mark and now account for 20 per cent of existing folios," says Suresh Soni, Chief Executive Officer, DHFL Pramerica Asset Management Company.
"SIP has become a generic brand, which means it is now counted among traditional savings options such as Public Provident Fund and recurring deposits, with greater benefits," says Anjaneya Gautam, National Head, Mutual Funds, Bajaj Capital.
The Association of Mutual Funds in India (AMFI) data show that the mutual fund industry added about 6.3 lakh SIP accounts per month in the current financial year; the average account size was Rs 3,200.
"If we were to highlight one big trend, it would be people taking the correct way of investing in mutual funds. In 2016, most investments came in existing open-ended equity funds and not close-ended funds or new fund offers. Almost all investments were in diversified funds (not in sector or thematic funds). And inflows into equity funds rose when markets corrected (not when they were peaking). Fresh SIP registrations rose 30-35 per cent," says Manoj Nagpal, MD and CEO, Outlook Asia Capital.
In essence, 2016 was a copybook year where investors followed all the right rules. This will help them significantly. It also reflects the growing maturity of both investors and mutual fund distributors.
Indians prefer parking their money in bank fixed deposits due to safety and guaranteed returns. To convince them to put money into mutual funds, which is a market-linked product and doesn't guarantee any return, is a herculean task. But fund houses are making progress by building trust among investors.
A part of the credit for this should also go to the Securities and Exchange Board of India, or Sebi, which has been introducing new investor-friendly norms to ensure transparency and protect investors' interest.
"Investors are showing confidence in mutual funds because of the transparency norms introduced by Sebi. This has made sure that people know where they are investing, at what cost they are investing, and what all comprises their portfolio," says Patel of Quantum Asset Management Company. Sebi has been tightly regulating mutual funds, which has helped prevent scams and hiccups, he says.
Sebi has been way ahead of other regulators in introducing forward-looking norms. Despite the fact that India's mutual fund industry is still at a nascent stage, it introduced norms on a par with those that govern some of the world's most developed markets. It, for instance, banned entry load and introduced a transaction charge of Rs 100 for existing customers and Rs 150 for new customers. It also asked fund houses to plough the exit load back into the scheme to compensate those who stay invested. The introduction of direct plans was a big step in bringing down costs for those who invest on their own.
Apart from these steps, fund houses were asked to make public the annual commission paid to distributors. At the same time, distributors were expected to disclose all the commissions - upfront, trail, or any other, to bring in more transparency.
Sebi has also proposed norms for separating the advisory business from the distribution business in order to curb mis-selling. The proposed regulations bar distributors, who earn commission from mutual fund companies, from advising people. For advisory services, they will have to register themselves separately with Sebi.
Though most industry players have welcomed the step, they say it will be premature to implement this regulation at this juncture as the mutual fund industry is at a very nascent stage.
"For a market such as India, we tend to oversimplify. If you really want to penetrate beyond top-15 cities, you need a strong distribution network. If the incentives for advisory are uneconomical it would be difficult for distribution to shift completely to advisory models. Also, retail investors don't understand the difference between an advisor and a distributor. If the current proposal is accepted, it will likely have a significant impact on the distribution business," said Prateek Pant, Co-Founder and Head of Products and Solutions, Sanctum Wealth Management.
B-15 cities grow
The mandatory investor awareness campaigns run by mutual fund companies made lakhs of people aware about mutual fund investing. As per AMFI data, assets from B-15 (beyond top 15 cities) locations increased from Rs 2.12 lakh crore in November 2015 to Rs 2.81 lakh crore in November 2016. The rate of growth in assets for B-15 locations was 32.41 per cent (26 per cent for the industry as a whole) during the period.
The increased contribution of B-15 cities can also be attributed to the higher incentives that fund houses get if they service customers in these locations. In 2012, Sebi had allowed fund houses to charge an additional 30 basis points as expense (100 basis points is equal to one per cent) if 30 per cent inflows or 15 per cent average assets under management, whichever is higher, in the scheme are from B-15 cities.
But not everybody is in favour of paying more to increase the reach of mutual funds. "The present regulatory model of tapping into Tier-II cities involves higher brokerage. In my view, this is an incorrect model. Though this has increased the percentage of assets from these cities, there has not been a proportionate rise in the number of investors," says Nagpal of Outlook Asia Capital. "This is a fallacious approach. One needs to remove this different pricing model under which a Tier-I city investor has to pay for the commission for the business done in a Tier-II city," he says.
"This should be changed to incentivise the addition of investors. Once the goal changes to bringing in new investors, it will be more helpful for the industry as a whole," he says.
The introduction of various other market-linked products has also helped more people understand mutual funds. "The understanding of market-linked products is increasing with the introduction of the National Pension System (NPS) and the equity option in the Employee Provident Fund (EPF)," says Pant of Sanctum Wealth Management.
The whole country is in the midst of a digitisation wave. Mutual funds, too, have been at the forefront of enabling digital/online transactions. Online investments are beneficial for both investors (less paper work) and fund houses (lower costs). This has the potential to increase the reach of mutual funds manifold.
Soni of DHFL Pramerica Asset Management Company says there has been a huge increase in online investments over the past four-five years. But if you want people to adopt digital in a big way, the onboarding process has to be made simpler, he added.
At present, almost all mutual funds have the online option for transacting. But the rigorous KYC (know your customer) processes still prevent several investors form completing the process online.
"Account opening is still a challenge as it requires paper movement if the investor is not KYC-compliant. This is the case even if the investor is a bank account holder," says Anjaneya Gautam of Bajaj Capital.
So, you can't sit at your home or office and invest in mutual funds, as the norms require investors to complete the KYC process in person at the fund's office or the registrar and transfer agent's office. However, some mutual funds are using innovative ways such as web cameras to get the KYC done online. Aadhaar-based e-KYC has been introduced but comes with an investment limit of Rs 50,000 a year.
Sebi, along with the Reserve Bank of India, or RBI, has introduced centralised KYC for all financial institutions. But this, too, has limitations. The centralised KYC, in the current form, has not been a game changer for mutual funds. This is because for an existing customer to shift to centralised KYC, a whole lot of data will be required, which again will be a big hurdle.
"As of now, even in centralised KYC, there are two different forms of KYC, with very low fungibility of KYC from banks to mutual funds. From mutual funds to banks, though, the fungibility is 100 per cent. This, in our view, is a significant limitation for mutual funds," says Nagpal.
"This has rendered the current KYC process of mutual funds redundant. It needs to be re-drawn. There should be single KYC for the entire financial sector and that should be enough to invest in mutual funds too. That should be the goal. We are still far away from that," he added.
Long way to go
Mutual funds' average assets surged to an all-time high of around Rs 17 lakh crore in November. Although the number may look impressive on a standalone basis, it is minuscule on a relative basis. "Mutual funds' assets are just 5 per cent of bank deposits," says Prateek of Sanctum Wealth Management.
This confirms what we are all well aware of - that most household savings are in physical assets such as gold and real estate.
"The mutual fund industry has a long way to go. Mutual fund is a product for the masses and we have reached just 1 per cent of the population. A lot more needs to be done," says Rajiv Shastri, MD and CEO, Peerless Asset Management Company.
Signs are good
The number is likely to rise further. The exposure of households to financial assets such as shares and debentures is rising. Indian households invested 0.7 per cent financial savings in mutual funds in 2015/16 compared to 0.4 per cent in 2014/15.
The trend is likely to continue. There are many reasons for that. One is that real estate and gold have failed to make money for investors over the past two-three years.
The S&P Sensex, the indicator of the broad equity market, has delivered an annualised return of close to 10 per cent over the past five years. Equity large-cap funds have returned 13 per cent during the period. And these returns are mostly tax-free as there is no capital gains tax on equities after one year.
Apart from the returns, it is much easier to invest in an equity instrument than in an asset such as real estate. To buy property, one has to do multiple checks. There is also a far higher likelihood of getting cheated. Finding a property with a good chance of appreciation is also not a easy task. In contrast, you can easily find a good mutual fund by doing some basic research as a lot of data is publicly available (we have shortlisted some top performing funds in various categories with the help of Value Research, a mutual fund ratings agency).
Also, now, demonetisation will make the traditional assets more unattractive, especially real estate.
"Demonetisation will be an indirect catalyst for the shift of household savings to market-oriented financial instruments such as mutual funds, equities and other capital market instruments. We say an indirect-catalyst as demonetisation, per se, does not create favourable conditions for capital market instruments. However, it does create unfavourable conditions for physical assets and fixed return financial instruments by lowering their attractiveness," says Nagpal of Outlook Asia Capital.
The overall outlook, however, is upbeat but challenges to increase investor awareness about mutual funds being a low-cost investment remain.