A Strong Foundation

A Strong Foundation

More and more savings are being invested in financial instruments. But for this to increase further, the industry has to shape up.

Defaults by the IL&FS group last year brought attention to the credit risks in debt mutual funds and exposures to NBFCs. Defaults by the IL&FS group last year brought attention to the credit risks in debt mutual funds and exposures to NBFCs.

The Indian mutual fund (MF) industry has grown exponentially over the last decade. However, defaults by the IL&FS group last year brought attention to the credit risks in debt mutual funds and exposures to NBFCs.

Assets under management grew from Rs 4.17 lakh crore on March 31, 2009 to Rs 23.8 lakh crore on March 31, 2019, an over five-fold increase in a decade. There are 26 million SIP accounts, and about 913,000 SIP accounts on an average were added each month during 2018/19, according to the Association of Mutual Funds of India.

There are various factors responsible for the fast expansion of the financial services industry as a whole. Not just MFs, in recent years, non-banking finance companies (NBFCs), too, have grown - at a fast 30 per cent per annum - catering to the needs of unbanked locations. However, in this business strong liability franchise(s) is imperative. This came into sharper focus in recent events.

And yet it has been business as usual for those names supported by big business houses or banks (about 80 per cent of NBFC business). This leaves the door open for the NBFCs that don't have strong backing or have a weak liability side to emerge with a new business model. A part of this aspect has already started playing out with an NBFC selling its commercial vehicle business.

From an MF perspective, the problem emerges when short-term liabilities are taken to fund long-term asset creation. Of these, MFs had exposure to short-term liabilities, and most of these have been honoured.

Any fixed income investment faces three types of risks - credit, interest rate and liquidity. On the credit side, an investor can face all three risks. Market risk is passed on to the investor, which is visible in the NAV. While market risk is handled well by the industry, there are challenges in liquidity risk. In credit risk, the decision to invest in a particular company depends solely on the MF houses' judgement. Following the rating(s) provided by agencies is the first step of an evaluation.

Recent events clearly show that adopting stringent steps in client selection and ensuring adequate diversification are critical to avoid an adverse impact of such credit events. Independent investment risk management teams, that oversee credit evaluation and approval processes, aids risk management. Investments should be made only after appropriate credit due diligence, including qualitative and quantitative analyses.

Apart from risk management, financial services must also keep pace with changes. Rapid adoption of digital transactions by investors and distributors has contributed to the growth of MFs, and the industry itself has adopted technology across processes, be it fund management, transaction processing or customer servicing. The fintech revolution is bringing in paperless transaction processing.

For those opting for traditional methods, while paperwork has reduced, it is not as easy as transacting on an e-commerce platform. Given that an investor already provides his bank credentials for the transaction, there is duplication of paperwork, since details are already available and been verified by the bank. Reliance on already-verified data can go a long way in easing the on-boarding time for investors.

The share of inflows through digital modes has grown from about 0.5 per cent two years back to nearly 10 per cent in June 2018. The role of technology can only get bigger. Digital is a win-win for all market participants. It will boost the industry's penetration, provide an effective medium to improve efficiency, reduce costs and pass benefits to investors.

Distribution can be another thrust area. There are just about 120,000 independent financial advisors and only 1,168 Registered Investment Advisors for a country of 1.3 billion people. Retail investors need significant hand holding and distributors play an important role. It is imperative that we have more distributors, but for that to happen distribution has to be remunerative.

All these measures together will help increase the flow of savings into financial instruments and will go a long way in sustaining the growth of the industry.

The writer is MD and CEO, ICICI Prudential Asset Management Co.