Challenges in MF industry

The domestic mutual fund industry has undergone significant transformation and seen remarkable growth over the past few years. What are the key challenges and triggers for the industry to sustain this growth and increase penetration?

* Expansion of MF products, addition of investor friendly features, spreading investor education/awareness:

* Seeking parity with other financial service providers in (know your customer) KYC documentation requirements, expense ratio flexibility etc.

* Spreading distribution infrastructure beyond urban/semi-urban areas.

The Remarkable growth of the domestic mutual fund (MF) industry, especially in the past five years, has been the toast of the town. The industry growth of 30% year-on-year during this period can be termed as nothing less than phenomenal. This is true when measured not only in terms of assets under management (AUM), but also in terms of the number of customers that the industry has added.

While this dramatic growth has come on the back of an extended bull run in the market from ’03 right up to early ’08, it is not unusual to witness such a growth pattern. Bull runs typically result in market growth more than anything else, as investors experience wealth creation, first hand.

Experience in the US also shows that it was the bull runs in 1960s and 1980s that led to growth spikes in the MF industry in that country. And that is encouraging, considering that today, one in every two US households owns MFs. Comparatively, MFs are an under-owned financial asset in India today. But this only underlines the immense potential of the domestic MF industry. Some other parallels with the $12-trillion US MF industry that emerge are hard to miss.

It was in 1924 when the first ‘open-end’ fund in the US was offered to investors. There was little progress during the stock market crash of 1929 and the Great Depression that followed.
Interestingly, this prompted introduction of regulations that not only ensured investor protection, but also brought greater transparency to the functioning of MFs.

A rising stock market and a strong economy propelled the industry through the late ’50s and ’60s, but it was not until the ’70s that the industry found its next milestone.

Interestingly, it came in the form of money market funds, which became hugely popular in a declining stock market scenario, helped by the switching facility, as well as the institutional investors who found these funds attractive.

Effective regulation to ensure transparency and investor protection, an uptake in the stock market and money market funds are the key themes that emerged from the US MF industry. Not surprisingly, we see all three trends reflected in the development of the domestic MF industry too.

In India, these developments alone have sent the industry’s assets soaring from $30 billion in ’05 to $140 bn in early ’08. Going back to the US industry for a moment, in 1985, 60 years after the first fund was unveiled the MF industry’s AUM had still not crossed the $500-billion mark. But in the 15 years from 1985 to ’00, the assets grew to $7 trillion.

This incredible growth was triggered by developments, which may not have reflected their full potential when they occurred, but they catapulted the industry to an entirely different level.

On the face of it, a buoyant stock market, coupled with the expansion of tax advantaged retirement savings, new fund products like wrappers, growing relevance of financial planners with fee-based charges rather than transaction-driven ones, and the introduction of platforms may have seemed like innocuous developments, but together they resulted in humongous growth.

Expansion of fund products and addition of investor-friendly features will be the key factors that will determine growth. As investors get savvier, they are likely to be more willing to diversify their portfolio.

Diversifying geographically will be one of the routes they will look to either through global funds, or feeder funds, or by investing directly in international funds, once regulations permit.