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Mutual fund growth: Reforms to propel the next phase
February 26, 2010

In this article, we analyse comparable factors that have contributed to the moulding of the Mutual Fund industry in India and US and whether there can be any parallels or lessons drawn for the Indian mutual fund industry from their US counterparts.


Author : Anand Desai



Untitled Document

In India, the mutual fund (MF) industry was born with the Unit Trust of India (UTI). When this public sector unit popularly known as UTI was created in 1964, the US already had a roaring MF industry. The reason that the MF industry in India today has 37 Asset Management Companies and such aggressive competition is largely because of the private sector funds.

Key Points :

  • Total Assets Under Management of Indian and US mutual funds have shown similar growth patterns over the last decade.
  • Governments in both countries provide tax incentives for investors in mutual funds. This differs based on the specific asset classes the government wants the funds directed to and also on the level of sophistication of the markets
  • It is a common fact that the capital markets aren't the friendliest of places for the smaller investors. This point is driven home for the investors by big events that occur in the market, especially scams and crashes
  • One way to look as mutual funds is as a wealth creation tool, but the big difference in the fund flows into mutual funds in the US and in India is that mutual funds hold a big chunk of the US Retirement Market's assets. The 2009 ICI factbook pegs this figure at 22%

 

Source: The Investment Company Institute Factbooks

Source: The Association of Mutual Funds in India Quarterly Updates

 

In terms of the total Average Assets Under Management (AUM) the world and the US (which is the biggest MF industry in the world) are way ahead of India. In the past decade and half the growth of the Indian MF industry has more or less mimicked the growth rate around the world.

The genesis of this comparison between an international MF industry and the one in India was a statement made by the ex - chairman of the AMFI, Mr. A P Kurien at a public forum saying how funds in India are awaiting a more conducive environment for growth, in the sense that the regulatory and business environment in India is not as good for business as elsewhere.

Let’s see how different it is and what has led to the growth of MF industry in US

The annual KPMG survey on the state of the investment management industry published in 2006 stated that the total AUM of US Mutual Funds or Investment Companies as they are called was US$11 trillion when the total financial assets were 56 trillion dollars in 2006. This shows what proportion of the capital flows are controlled by the US MF companies in the US financial system. This is a good way to perceive the penetration of the MF industry and its weight in the national financial scheme of things. If one were to compare this with the scenario in India, the total AUM of Indian MFs was around US$110 billion when the size of the entire financial assets in India was around 1.8 trillion dollars. Where US funds controlled a fifth of the financial assets, Indian funds controlled just about 6.1 % of the total financial assets in the country.

ICI's 2009 Investment Company factbook data shows that more than 52.5 million households with a collective total of more than 92 million investors hold mutual fund products. The one important factor is that the US mutual fund industry is a lot older than the Indian mutual fund industry and overall the GDP of the North American nations has left a lot of disposable income over time in the hands of US investors. Even though Indians have the highest percentage of income saved (around 28% - Sourced from RBI) in comparison to the BRIC and developed countries, the percentage of income invested is nowhere near. The capital markets come pretty low down in the preferred list of investment avenues for the average Indian. AMFI has various initiatives in the pipeline to increase investor education like investor education camps, seminars and outreach programs. As the Indian economy matures and India’s market depth increases, the markets will be accepted more readily by different kinds of investors.

Tax incentives

Dividend income from mutual fund units is exempt from income tax. Further, investors can get rebate from tax under section 80C of Income Tax Act, 1961 by investing in Equity Linked Saving Schemes of mutual funds. Section 54EA and 54EB provide relief from long-term capital gains tax in certain specified schemes. Such incentives have been long provided by the government of India with a view that savings and further investment of savings should be promoted. Mutual funds have been direct beneficiaries of this as tax savings are one of the major incentives for investments in mutual funds. In that sense the US which is probably the best example of market demanded regulations, has always had the lowest of tax burdens for investors. However this has changed post the financial crisis. Currently, the DeFazio Harkin tax is under consideration, it is meant to tax all securities transactions in the market. This is something like the Securities Transaction Tax (STT) in India but with mutual funds, the STT is only applicable on redemptions (not sale unlike equity trades) and directly taxed to the individual investors. The major difference however is the fact that the Defazio-Harkin tax is meant for only securities transactions on the market and does not affect redemptions. Either ways it is interesting that the Indian government has been sufficiently accommodative to mutual funds and towards investments in mutual funds.

Simple investment vehicle for ordinary investor

One very important reason for the success of mutual funds over the world has been the fact that the average person views the financial markets as an unsolvable puzzle. When scams or crises happen, the retail investor is left in the lurch and as a result finds a safety in investment through mutual funds because they are professionally managed. Be it the Madoff Ponzi scheme or the Harshad Mehta scam, even as regulators put more and more measures in place to protect the individual investors, new scams and crises inevitably crop up. It was observed in a survey that where a country has scams, the investment in mutual funds increases (Ajay Khorana, Henri Servaes, and Peter Tufano 2002). Today the Indian regulatory framework for Mutual Funds is as wide and as liberal as any in the world, in the Indian circumstance as also in the absolute sense.

Long-term benefits

The biggest difference between how funds are perceived in the financial scenario is reflected in the use of pension plans within mutual funds. Pension and retirement benefits are thought of as sacred in India. Most government and private organizations that have post-employment benefits for their employees do not invest in mutual funds for increasing their pension amount. Plans like the 401 (k) plans in the US invest employees’ benefits in mutual fund schemes and hence grow their retirement amounts. The employees even have the option of choosing where the money can be invested, which fund, which type of scheme etc. This has made MF penetration very high. This is however not the case in India.

 

Conclusion

  • In US, for a country that is the most privatized country in the world, almost all of the funds are privately backed. However, the private funds have also scored higher in the Indian markets. According to the Handbook of Statistics on Indian Economy(15 September 2009) published by the RBI private funds hold more than 60% of the total AUM of the Indian mutual funds industry. This goes to show the growth in the concept of the mutual fund and how it has become generally acceptable.
  • If bank rates were taken as a benchmark to relatively judge the charges levied by the mutual funds in India and the US, they are almost exactly comparable. It is probable that the concern highlighted by Mr. A P Kurien regarding regulations stems from the changes that were brought in last year. The removal of entry loads has made mutual funds an uninviting product for distributors since they can still gain more commission from other financial products (mainly Insurance).
  • The fund industry does seem to be going through a rough patch now with quite a large loss in the customer base. However, as a concept of a wealth creation tool, the relevance of the mutual fund cannot be ignored with the changing demographics and the need for better asset management and the scoping of better growth opportunities. It is only a question of when the next spurt, firstly of return of the lost customers and then a growth beyond the previous numbers will happen.
  • Even though it is only seventeen years old, the private fund industry has grown well and not much seems to be going wrong, with ample government support or atleast as much as is justifiable. It does seem that even though mutual funds may complain that the level playing field for public and private mutual funds is much fairer than in the banking or any other financial services sector, there is scope for further opening up of the industry.  Certainly, there are issues like taxes and investment curbs (where mutual fund investments have to be guided by ratings of the base investment asset) that can be dealt better by the regulator, but, the most important aim for the regulator over the past decade has been to infuse confidence in the investor and the balance between that and market growth has been achieved well.

 

 

iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.

 


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