Upstarts Disrupting the MF Industry

Navi’s push vanguard The nascent yet highly disruptive is the latest in a series of moves to shake up India’s usually conservative and stagnant mutual fund industry, which has hitherto been dominated by some large bank-owned asset managers.

Winds of change started blowing in December 2020, when a new circular from the market regulator Securities and Exchange Board of India (SEBI) allowed fintechs to launch their own mutual fund products- even if they are not profitable. However, SEBI has mandated that such new-age asset management companies (AMCs) should have at least a net worth of Rs. ₹100 crore (from above ₹50 crores which is currently required for a regular AMC). This new codified minimum net worth should be maintained until the new AMC continues to make a profit for at least five years.

After the SEBI circular, an industry that was already seeing increased interest from fintech saw a small explosion of new entrants or general entrants who were waiting for a license to operate. Major upstarts that have received a new license in recent months are discount brokerage Zerodha, Prashant Khemka’s White Oak Capital, Bansal’s Navi Mutual Fund and NJ Mutual Fund, which is owned by the MF distribution company of the same name.

Other prominent persons who are waiting in the wings are Deepak Shenoy of Capital Mind, renowned investor Rakesh Jhunjhunwala and Helios Capital founder Sameer Arora.

Passive investing (tracking an index rather than actively choosing a particular stock) is a key element of a newcomer’s strategy. Focusing on international funds and lowering expense ratios are other things. Several other cards up his sleeve are yet to be revealed. One thing is certain though: The hazy world of mutual funds is in for some big changes.

“We have treated India as an equal market and painted all (investors) in India with the same brush. Saurabh Jain, Managing Director and CEO, Navi Mutual Fund said, “There are a lot of innovations waiting to happen. A mutual fund portfolio should be like a Subway sandwich. You choose your toppings and sauces according to your risk appetite and Target. The products we have applied for so far reflect the same (philosophy).”

Similar to the banking sector, the sector of mutual funds has been a strictly regulated business in India. The stringent conditions meant that very few licenses were issued each year and that incumbents usually received extraordinary benefits simply by existing.

“(As of now), AMC will launch the same set of products under different names. There was no attempt to think outside the box,” said Deepak Shenoy, founder and CEO, Capital Mind, which has applied for a mutual fund licence.

“Old established players (have) leveraged their affiliated banks to increase assets and are committed to that labor intensive model. But now, you can directly reach out to investors online through technology. You don’t need a huge army of distributors or relationship managers,” Shenoy said.

It remains to be seen whether this is all just one big talk or whether the ground beneath India’s growing club of investors will actually turn in a positive, consumer-friendly direction in the near future.

shadow on active money

Every year the S&P Dow Jones Index releases a report documenting the performance of actively managed mutual funds in India. As per the SPIVA report, for the first half of 2021 (ending June 2021), the market indices outperformed 86% large-cap funds, 57% mid-/small-cap and 54% equity-linked savings schemes or ELSS funds . .

Over the 5 year period, the figures are the same at 83%, 70% and 76% respectively. Despite questions about the effectiveness of actively managed funds, the mutual fund investor base in India largely ignores the data. Part of the reason for the collective shrug is the ecosystem through which the mutual fund industry operates.

AMC paid commissions to distributors who, in turn, served the investors. The commission was much higher in the actively managed fund category than in the index fund or exchange traded funds (ETF). It was in no one’s interest to reduce the cost and commission associated with fund management.

Although in 2015, Employees Provident Fund Organization (EPFO) announced that it will invest 10% of its incremental collection in ETFs. Later it was increased to 15%. The EPFO’s decision increased the hitherto marginal segment of the mutual fund industry and offered the benefits of scale to mutual funds that wanted to focus on this segment.

Meanwhile, another revolution was underway that challenged the ecosystem of ‘regular’ or commission-bearing mutual funds, largely distributed by large banks. This was the rise of fintechs registered as investment advisors (popularly known as RIAs).

These fintechs gave investors the ability to invest in direct (commission-free) schemes of mutual funds at no additional charge and a substantial portion of their marketing budget, highlighting the impact of commissions and costs that investors received. As a result of these shifts, the share of passive mutual funds had already started rising rapidly – ​​from 1.1% of total AUM in January 2015 to 10% in August 2021.

Bharat Bond Experiment

In December 2019, Radhika Gupta, Chief Executive Officer of Edelweiss Mutual Fund and one of the biggest social media influencers in the industry, was engaged in a frenzy of activity. His small AMC, Edelweiss Asset Management Company, had received an order from the government to manage India’s first passive debt mutual fund.

Until then, conventional wisdom insisted that while passive investing could work in large liquid equity markets, debt required the hand of a fund manager. Lack of liquidity would mean that mutual funds would at times not be able to meet large redemptions. However, within a month or so, Gupta’s team had overcome the unthinkable. The first set of Bharat Bond ETFs was born and collected more ₹12,000 crores. Passive investment came in debt mutual funds.

NS Bharat Bond The launch was followed by a range of copycat products from the rest of the industry. The success also opened the door to product innovation, a strategy new entrants are banking on right now. “With the industry shake-up now underway, I expect many more products to emerge,” said Shenoy of Capital Mind. “The recent permission to set up silver ETFs is a case in point. We can do many ETFs tracking other stuff.”

Even as new entrants rock a strong ecosystem, the industry itself has been hit by SEBI’s initiative launched in May 2021 to set up a centralized platform for buying and selling mutual funds . The platform called MF Central will also handle service requests. It will be funded and run by Registrars and Transfer Agents (RTAs) and potentially threaten the business of India’s vast army of distributors, who are an integral part of the traditional MF ecosystem.

MF Central can level the playing field between established and new AMCs, reducing the need to set up comprehensive customer service and operations teams. Dhirendra Kumar, Head, Dhirendra Kumar said, “With initiatives like MF Central, the cost on regular services issues such as enrollment and broadcasting will fall across the board and it will open the playing field between the incumbents and new entrants with already large service potential. can flatten.” Executive Officer, Value Research, a mutual fund data and analytics portal.

However, Kumar is a skeptic and does not believe that a big shift is underway. “I don’t think new fintech players will take away a significant market share from existing ones or lead to a downward race in terms of fees and expenses. Brands still hold a lot of power in India and few existing players have powerful brands. Instead, new entrants are likely to expand the market and bring in smaller investors, who are currently not well served by the distribution ecosystem,” he said.

emerging challenges

Srikant Meenakshi, founder of Priminvestor.in, is also cautious about the extent to which the players of the existing industry may be challenged. “Creating a competitive advantage in the mutual fund industry over product or strategy is not easy. When a fund house launches a successful model, it is rapidly replicated. Take the PPFAS flexicap model of investing partially in US stocks. Many other fund houses are also doing the same. Similarly, take the Motilal Nasdaq ETF. Many fund houses have launched their own versions.”

Meenakshi said that it is true that what happened after the launch of Bharat Bond ETF, growth of new players can spur innovation. “But the space for that is limited because these strategies are easily replicated. A lot of new players are just middlemen—distributors or fintechs—who (now) want to do backward integration. It’s a fundamental tenet of business thinking—if you want to do that.” Selling someone else’s product, so in the back of your mind, you consider launching your own.”

The current wave of disruption is also likely to lead to a short-term downside downside. There will be chaos and product confusion in an industry that already has a vast array of products.

In October 2017, SEBI issued a comprehensive circular on classification of schemes. The market regulator created 26 categories of open-ended mutual funds and restricted mutual fund houses to only one scheme per category for most of them. One of the objectives of coming up with this circular was to reduce the complexity and duplication in the world of mutual funds.

However, like many other laws in India, this attempt failed. According to the Association of Mutual Funds in India (AMFI) data, the number of open-ended mutual fund schemes increased from 828 in October 2017 to 1,056 in August 2021. The entry of new houses has added to this huge agglomeration.

“The vast number of schemes and their ever-increasing volume is an issue. Today, AMCs can launch any number of close-ended or thematic plans. If these are sold on the basis of recent performance, it could result in a bad experience for the investor,” said Kumar of Value Research.

However, new entrants feel that they have better control over the pulse of India’s millennials who are going to earn and invest money over the next few decades. According to Navi Jain, the growth in mutual fund investor base will come from young people (18-35 age group).

“These investors are looking for simplicity as they are used to apps like Amazon, Flipkart, Uber and Swiggy. They expect a similar experience from mutual funds – simplicity of product and technology. Today, there are about 1,700 funds—all you need is a recommendation engine to help you choose what’s right for them.”

Jain also acknowledged that cost was a significant difference to his asset management company.

“Take the young investors of today. They are used to compare prices across multiple apps. Why won’t they do the same with mutual funds?” he added.