Retail wallets closed to Indian mutual funds

By Indrajit Basu & M H Ahsan

Ask bankers or a heads of insurance companies in India about how many retail customers they have added in the past year and chances are that most would give you a number close to the nearest hundred. After all, retail clients are the backbone of their growth, they say, and acquiring new clients is their top priority. But place this question to a fund manager of any of India's 44-odd mutual funds, and most would draw a blank. No official numbers regarding retail investors in mutual funds are available, but "we have many", they say. Some even evade the question and try to direct attention instead to the sizzling growth in the amount of money they manage (called assets under management - AUM in industry parlance), which most funds consider a key benchmark for their performance. They can always find an excuse, though, for not having enough retail clients.

According to reported figures, the penetration of mutual funds in India has languished at a mere 3% of household savings, compared with 16% in most developed and developing economies. "If you compare the overall investments of the retail investors, the mutual-fund industry is still struggling to gain the attention of the retail investors," said Krishnamurthy Vijayan, director and chief executive officer of JPMorgan Asset Management Co. Indeed, although the Indian mutual-fund industry has finally started growing like a teenager since mutual funds in their true sense were opened to the private sector in 1993, the fact is that the sector continues to be the favorite for only the big guns, while most investors from the street push this investment avenue, supposedly the retail investor's best, way down their preference list. On the face of it, though, the mutual-fund industry has never had it so good.

The AUM or the total corpus of this industry grew by a stunning 21% over the year ending July to exceed US$125 billion. But, said T C Nair, a member of the country's capital-market regulator, the Securities and Exchange Board of India (SEBI), even as it is "astonishing that assets managed by mutual funds have doubled in less than 18 months, the mutual-fund industry is still very urban and geared toward institutional investors". And this has happened despite the fact that the industry aggressively positions itself as a safe investment avenue that can offer better returns than most fixed-interest-bearing investment instruments, such as bonds and deposits. Take these numbers, for instance: according to SEBI, of the $125 billion AUM, as much 81% comes from the eight largest cities of India, while half of the AUM "belongs to corporate clients, banks and financial institutions". But there's not much participation of retail investors in the other half, either.

According to industry numbers, there are about 32 million retail accounts in Indian mutual funds. "However, the point to note is that much of this too belongs to the high-net-worth investors, because most usually invest though multiple accounts," said Jhelum Chowdhury, a financial planner and a mutual-fund broker. Therefore, said Krishnan Sitaraman, head of fund-services and fixed-income research for the credit-rating agency CRISIL, "Although there's no concrete information on that [retail investors in mutual funds] number, we reckon that no more that 25% of the AUM belongs to the retail investor." Compare mutual funds in India with its peers in the developed countries, say the United States, where mutual funds truly function as they should - to increase the wealth of smaller investors - the picture looks completely different: more than 80% of the AUM belongs to retail investors.

The ratio is similar in Europe and elsewhere in Asia. So why don't millions of investors find Indian mutual funds hot? "One major issue with less retail participation [in mutual funds] is the income level of smaller investors," said Rachana Baid, a professor at the Mumbai-based Indian Institute of Capital Markets. "Indian investors follow a typical investment hierarchy where risk-fee investments like bank deposits and bonds get the top priority and, after making such investments, there is little money in the hands of the investors to invest in equity-linked mutual funds."

Then there's the question of risk perception. Experts say that since equity-linked mutual-fund plans - the only mutual-fund plans that retail investors actually invest in - invest primarily in stocks, retail investors perceive "such investments as a proxy for a punt on the stock market", said Krishnamurthy Vijayan of JPMorgan. Moreover, added Baid, the Indian mutual funds have not been able to communicate their risk profile to the retail investors segment properly. "It is true that mutual funds per se could be risky too, but when one considers this investment avenue from a longer-term perspective, say 30 years, the daily or even few months of volatility of the stock markets should not matter," said Baid.

Nevertheless, the biggest reason Indian mutual-fund plans haven't been able to penetrate deep into the retail segment is the mutual funds themselves: all have the principal focus on growth of their AUM in which corporate and institutional markets offer an easy way. "And there are understandable reasons for it," including a sweetener in the Indian income-tax laws, said Dhirendra Kumar of Valuresearch, which claims to be the first dedicated fund-research company in India. After tax concessions extended to mutual funds in 1999 where dividends from equity funds were made tax-free and where debt funds were taxed concessionally at 10%, "Companies and other large investors prefer to put their money in debt funds of mutual funds instead of putting their money directly in fixed-income-bearing securities, where the earnings are treated as interest income and hence taxed at much higher rates," said Kumar.

That is also why, say industry sources, about 65% (although SEBI claims it is about 50%) of the AUM consists of debt plans. "Moreover," said Krishnamurthy Vijayan, "most mutual-fund companies in India are grossly undercapitalized [meaning they do not have enough capital to expand their marketing efforts], so they tend to address the meaty area [where one marketing call could get them the business of many retail clients] to grow." Small wonder that SEBI is unhappy about the way mutual funds in Indian operate. In a public forum last month, SEBI chairman M Damodaran pointed out that "the mutual-funds industry seems to be prematurely patting itself on the back" and that "the question of who has made what sort of growth provokes more questions than it provides answers". Damodaran also urged the industry to examine the possibility of getting different kinds of money into funds, rather than bank overwhelmingly on institutional investors, since such "large investments by corporate houses in mutual funds generate conflict of interest".

The truth, then, is that in India, mutual funds are hardly what their original concept mandates: individual investors should form the bulk of fund investors or participants. But the good news is that this may be changing. Lately, claim both Vijayan of JPMorgan and Vikaas Sachdev, country head of business development for ING Investment Management, some large fund houses have started venturing deep into the micro-investment segment through the systematic investment plans route, and by getting non-government organizations to mobilize funds from even rural areas. "

The inflection point is now," said Sachdev. "With rising disposable incomes and confidence following three years of a sustained bull run, the share of the retail investors' wallet in the MFs [mutual funds] is going up; the industry expects that retail participation [will] grow much faster in the next few years."