From a single-player monopoly in 1964, the Indian mutual fund industry has evolved into a high-growth and competitive market on the back of favourable economic and demographic factors. As of August 2012, 44 asset management companies (AMCs) were operating in India with assets under management (AUM) of INR 6.4 trillion. However, after several years of persistent growth, the industry witnessed consistent declines of 6.3 percent and 5.1 percent in its AUM during FY11 and FY12, respectively1. One of the reasons could be the changes in regulatory guidelines-example ban on entry load, stringent KYC norms, guidelines on transaction charges, tightening valuation and advertisement norms - which were introduced in a short span of time thus giving less time to the industry to adjust in the new environment.
Source: Various monthly publications of Association of Mutual Funds of India (AMFI);ICI Factbook 2012
Note: based on GDP and AUM as of December 2011
Further, the penetration of mutual funds in India (as measured by the AUM/GDP ratio) remains low at 4.7 percent as compared to 77.0 percent in the US, 41.1 percent in Europe and 33.6 percent in the UK. Mutual funds also constituted only 3.3 percent of households’ financial savings in FY10, which further contracted to -1.2 percent and -1.1 percent in FY11 and FY12, respectively, due to large redemption and capital losses2.
Source: Various monthly publications of Association of Mutual Funds of India (AMFI); ICI Factbook 2012
Note: based on GDP and AUM as of December 2011
Besides low penetration, concentration of mutual funds to a few major cities has been another concern for the sector. Most AMCs and distributors have limited focus beyond the top 20 cities, as is evident from the limited distribution channels and limited investor servicing available beyond these cities. The top five cities contributed approximately 71.1 percent of the total AUM of the mutual fund sector, with Mumbai only accounting for about 42.1 percent in FY12. Lack of incentives for distributors to expand in small cities has resulted in mutual funds becoming an investment product in the hands of urban Indians3.
Such challenges have led the Securities and Exchange Board of India (SEBI) to adopt certain measures to re-energize the mutual fund industry with an objective to restore sustainable high growth for the sector.
To start with, AMCs are allowed to charge an additional total expense ratio (TER) upto 30 bps, if 30 percent of their net sales or 15 percent of their AUM (whichever is higher) originates beyond the top 15 cities. If inflow from beyond the top 15 cities is less than 30 percent of net sales or 15 percent of AUM, the proportionate amount will be allowed as additional TER. While this step may reduce investors’ returns in the short term it may give AMCs more scope to incentivize distributors to expand their geographical reach. SEBI has also decided that AMCs should not bear the service tax (12.36 percent) payable on investment and advisory fees; instead, it can be charged in addition to the TER. This move is in line with the SEBI’s attempt to bring the mutual fund sector at par with other sectors4.
In short-term, investors’ returns may be affected due to this move but investors are bound to gain in the long-term as AUM increases.
In order to help AMCs widen their customer base in tier-IV to tier-VI cities, SEBI has also relaxed the mandatory requirement of a permanent account number (PAN) card or bank account for cash investments of up to INR 20,000 per financial year. Further, the regulator’s recommendation to include equity mutual fund schemes under the Rajiv Gandhi Equity Savings Scheme (RGESS) that offers tax breaks to small investors could help AMCs attract new investors in capital markets4.
In another step to stimulate the distribution network, SEBI has proposed to simplify the distributors’ registration process and widen the distributor by including postal agents, retired officials from government, banks, retired teachers and other similar professionals (such as bank correspondents) for the distribution of simple products. Although this could help AMCs expand their footprint, they will need to be cautious of the increased risk of mis-selling schemes due to lack of knowledge on investors part. SEBI has introduced various levels of certification and registration depending on products and services offered, but a mechanism to monitor compliance by the individuals must be identified4.
SEBI has also mandated a single expense structure under a single plan to eliminate differential treatment between retail and institutional investors. However, to promote direct investment and to be fair to direct investors, a separate plan for direct investments with a lower expense ratio and a separate net asset value (NAV) has been proposed. One of the outcomes of this step could be less distributors’ commissions as many institutional clients who are major investors and are well-informed may prefer the direct route. But on the other hand, retail investors who need help to select the most suitable scheme and complete requisite paperwork would still invest through a distributor4.
Low customer awareness and financial literacy are one of the biggest roadblocks in channelizing household savings into mutual funds. In a bid to enhance customer awareness, SEBI has mandated AMCs to set aside at least 2 bps of their daily net assets annually for the investor education campaign. AMCs should also make disclosures regarding the investor education and awareness initiatives undertaken5.
To further strengthen the regulatory framework and to make it increasingly transparent, SEBI has asked AMCs to upload monthly portfolio disclosures and half-yearly financial results on their websites. It has also mandated AMCs to report additional annual disclosures such as gross inflow, net inflow, average AUM, and distributor-wise gross inflow on their websites. The regulator has also asked its panel to study regulatory provisions in some of the international jurisdictions (such as the US and the UK) to propose ways to increase inflow to mutual funds. The report is expected to be released in the next three to four months5.
While SEBI has announced various measures to increase the penetration and improve the distribution network, increasingly liberal TER with fungibility was expected. Currently, equity mutual funds can charge a maximum of 2.5 percent as TER, of which 1.25 percent may be allocated as fund management fees/charges and other expenses (such as marketing, distribution and operations) each. Any expense above 2.5 percent has to be borne by the AMC. Initially, SEBI proposed the removal of sub-limits on expenses, giving AMCs the freedom to allocate the 2.5 percent TER the way they wanted to. This could have helped AMCs to incentivize distributors more effectively and attract them to sell mutual funds more actively, which was hampered after the ban on entry loads6.
To summarize, enhancing TER (up to 30 bps) and charging service tax separately are expected to help fund houses improve their reach and energize the distribution network.
Although investors’ returns will likely be compromised in the short term, enhanced presence and a rejuvenated distribution network are likely to be beneficial for investors in the long term. Relaxing KYC norms for small investors, widening the distributor network to include postal agents and retired officials, and recommending the inclusion of equity scheme mutual fund products under RGESS could help strengthen the last-mile connectivity in mutual fund distribution.
Through its recent initiatives and announcements, SEBI has given a muchneeded boost to the mutual fund sector but the industry is waiting for a longterm initiative by the regulator that will put this sector amongst the most preferred instrument of investment.
1. Various monthly publications of Association of Mutual Funds of India (AMFI)
2. RBI Annual Report FY12
3. AUM by geography, AMFI, March 2012
4. Steps to re-energize Mutual Fund Industry, SEBI. September 2012
5. Steps to re-energize Mutual Fund Industry, SEBI. September 2012
6. Press Release, SEBI Board meeting, August 2012