Can you spot the retail investor?- Business News

Can you spot the retail investor?

Companies and institutions dwarf retail investors in the Indian mutual funds arena and there's unlikely to be a trend reversal soon.

  • December 16, 2010  
  • |  

It's a classic Hegelian thesisantithesis dialectic. The swelling ranks of retail investors should make India a happy hunting ground for mutual funds (MFs), which explains the exponential jump in the number of players. From just 20 in 1999, today we have 39 players. The antithesis: going against the global drift, retail investors still shy away from MFs, preferring risk-free, government-backed, fixed-return and low-yielding instruments instead.

Retail contribution to the assets under management (AUMs) of the industry is just a quarter, with companies holding sway - contrast this with a dominant 84 per cent in the United States. That's clearly a big missed opportunity for both - India's teeming middle class and the MF industry.

Globally, and in India, MFs outperform most other asset classes, making them an attractive investment option for the middle class. For MFs, too, retail flows are desirable. "Retail offers diversity and stability, unlike the chunky institutional flows," says Tarun Bhatia, Director of Capital Markets at CRISIL Research.

So, what keeps Indian retail investors away from MFs? "Until there is substantial improvement in financial literacy levels, MF penetration in India will remain abysmally low," says Saurabh Nanavati, CEO of Religare Asset Management Company (AMC). Which perhaps explains why the industry's total AUM is less than the funds managed by Life Insurance Corporation of India alone. A wellinformed investor population would, logically, buy better financial products and make more productive use of its savings.

To beef up penetration levels, say experts, MFs in India would have to actively spread financial literacy through workshops and awareness campaigns. "Any measures and initiatives for spreading awareness should be structured with a long-term horizon in mind," says Jairaj Purandare, Executive Director and Leader of Financial Services at PricewaterhouseCoopers .

India's most financially literate investors have traditionally been concentrated in Gujarat, Maharashtra, Rajasthan and the larger cities in the south. "Our sense is that there are approximately 25 million individual investors around the 47.9 million folios, or investment accounts, registered with the MFs, and this number mostly comes from 28 major cities and towns," says Purandare. Even this is just a fraction of the 190 million people who have some form of savings such as post office and bank deposits and life insurance policies. So, there's still a large and relatively untapped market for MFs.

Low financial awareness levels also explain the surge in popularity of Unit Linked Insurance Plans (ULIPs) among the small investors. ULIPs have traditionally been seen as a proxy for MFs with insurance thrown in for good measure. According to the Insurance Regulatory and Development Authority (IRDA), during 2009-10 the share of unit-linked insurance business continued to climb, from 51 per cent to 55 per cent of the total life insurance business.

Industry insiders also stress that the policy framework is skewed in favour of ULIPs - a major reason why the industry hasn't been able to evolve a distribution network as yet. Most distributors have preferred to peddle ULIPs largely because of the lucrative commission structure.

Insurers passed on a big chunk of the fee - as high as 40 per cent - on first-year premiums to advisors. MFs, in contrast, paid distributors through an entry load on investors, which was capped at about two per cent. The ban on entry load imposed by the Securities and Exchange Board of India (SEBI) in August last year has only added to the woes of the industry.

It forced MF distributors to make money by advising investors. As a result, distributors simply stopped selling funds and concentrated on ULIPs and company fixed deposits. And MFs have still to recover from the blow. About 5,000 investor folios were redeemed daily from equity funds over the last month alone. "Our mutual fund team is practically selling ULIPs for the last few months," says a senior official of a leading distribution house, requesting anonymity.

New norms for ULIPs by IRDA, then, are seen as a belated course correction to reposition them as insurance products and address these anomalies. The lock-in period for ULIP investors has been increased from three years to five years, making it a longterm investment vehicle. That apart, agent commissions on ULIP sales have also been capped at three per cent.

A poor distribution network remains the Achilles heel for the industry. MF investors are serviced by 60,000-odd independent financial advisers, or IFAs, who function as agents. Life insurance firms, in contrast, have about two million agents. And given the low margins in the business, due to high manpower and infrastructure costs, majority of IFAs also sell other financial products such as life insurance and postal savings and broking and portfolio management services, thus diluting their focus.

The recent IRDA measures are likely to improve matters, say experts. "With the cap on commission, selling ULIPs is no more a lucrative proposition. This will bring some amount of level-playing field and distributors are likely to show greater commitment to mutual funds," says Dhirendra Kumar, CEO of Value Research India.

But the industry insists that unless SEBI revokes the ban on entry loads, IRDA's initiatives will only be seen as half measures. "Since the retail reach and AUM size has not reached the desired inflection point, distributors may not be able to survive only on advisory fee," says K. Venkitesh, National Head of Distribution at Geojit BNP Paribas.

This is a serious problem for an industry where distributors are indispensable because only a small fraction of investors go to fund houses directly. "Our business models, even today, are not tuned to reach out to the customer directly," says Nimesh Shah, Managing Director and CEO of ICICI Prudential Asset Management Company. The industry, though, is optimistic that most of these regulatory hurdles would be sorted out soon.

SEBI, most analysts feel, is gradually creating a solid regulatory framework to build a vibrant MF industry. A slew of decisions by the markets regulator over the last couple of years has made MFs more accountable and transparent. For example, fund houses have been asked to disclose all complaints received by them on their respective websites and in their annual reports.

Also, funds now have to disclose their portfolios every month - in the US it's six months - and break-up of expenses every six months. Says Kumar of Value Research: "Our mutual fund industry is actually much better regulated than the US and, for a change, they could learn from us." Adds Nitin Rakesh, MD and CEO of Motilal Oswal Asset Management Company: "This is the new normal and we all have to accept it." He says that even more scrutiny on costs and selling practices is under way.

SEBI, meanwhile, is keen to highlight the efficacy of MFs as a long-term investment avenue. Most investors still see MFs as a quasi stock market product and prefer to invest in growth schemes, unlike corporate houses, which take refuge in the safety of debt schemes. And with closed ended schemes on their last legs, investors churn their portfolios regularly.

According to the Association of Mutual Funds in India (AMFI), historically, an equity fund remains locked in for an average of 18 months; around 40 per cent of retail investors exit from equity funds before they complete two years; and even among high networth individuals (HNIs), only 48 per cent remain invested in equity funds for more than two years.

H.N. Sinor, Chief Executive of AMFI, sees retail investors gradually comprehending the value of MFs as an additional asset class. "The US MF industry has also gone through this and they also had a similar situation. We are still maturing," he says. More than 25 per cent retail ownership in an industry that's still evolving, Sinor feels, is a positive development.

Players, too, believe that the opportunity is large over the longer period. India currently has only 40 AMCs, while many of its Asian peers like China, Korea, and Taiwan have over 60-70 players. The US has a mammoth 600.

"There is an opportunity for more players to enter, but the payback will be over a longer period of time, perhaps over 10 years for the newer players," avers Nanavati, the Religare AMC CEO. Spreading financial literacy and a supportive policy environment could make MFs a preferred investment option. In time.