The Indian mutual fund industry has been a subject of much discussion and debate as the industry has hardly grown over the last four years after the Securities and Exchange Board of India introduced a ban on the entry load — fee charged to cover the distribution and some other cost — in 2009 and also due to the weakened global and domestic economic condition.
While the average AUM of the industry has grown at a compounded annual growth rate of 2.6 per cent since December 2009 to Rs 8.82 lakh crore in December 2013, a recent study released by the Securities and Exchange Board of India points out that lack of healthy participation from a large part of the country is a major reason for this slow pace of growth.
The report titled, “Penetration of Mutual Funds in India: Opportunities and Challenges” prepared jointly by two senior Sebi officials and an ED and a Research Associate from Bharti Institute of Public Policy, Indian School of Business, Mohali, picks up lack of penetration, low supply of products in cities beyond the top 15 as major reasons for the slow growth of mutual funds.
While the top 15 cities contribute to 87 per cent of the industry’s AUM, the top five (Mumbai, Delhi, Chennai, Kolkata and Bengaluru) contribute 74 per cent of the entire AUM. This clearly shows that there is concentration of AUM in few cities and thereby reflects on the need to break new grounds and bring new investors from tier II and III cities in the net.
Issues hampering the industry growth
Pointing out the reasons for low penetration beyond top 15 cities, the report attributed it to both demand and supply related issues. While low levels of financial literacy, cultural attitude towards savings are the issues on the demand front, low supply of mutual funds from AMCs outside major cities and lack of quality manpower in these areas have been suggested as supply related issues.
Having distributed Indian districts in ten parts with the 1st decile comprising districts with highest GDP and the last decile comprising those with lowest GDP, the team compared the AUM to GDP ratio of these ten segments. It found that against the AUM to GDP ratio of the country of 7 per cent, there has been a sharp contrast in the numbers for the first decile and the rest of India. If it stood at 29.5 per cent for the first decile, for the rest of India it stood at a low of 1.8 per cent.
“This skewed origination of AUM in India is its single biggest challenge and its biggest opportunity at the same time,” said the report adding that, “This under penetration of financial inclusion is not unique to mutual funds, but a deeper structural problem characteristic of the Indian financial sector. More than half of India’s population does not have any access to formal banking services.”
If financial inclusion is an issue, financial literacy is another hurdle that mutual funds need to overcome along with the traditional investment practices that people have. The report states a large number of households are extremely risk averse and they also do not know how and where to invest in a mutual fund.
“Investors perceive mutual funds as risky investments and tend to invest their savings in tangible assets such as gold, jewelry, real estate or fixed deposits in banks,” said the report.
If knowledge and comfort of investing is an issue the report further highlights the fact that the different kinds of large number of schemes often end up intimidating an uninformed investor as a result of which they move towards less complicated investment options which they understand.
“This combination of ignorance, risk-aversion and mutual fund complexity are huge hurdles that AMCs in India will have to overcome if there is to be any increase in retail participation in mutual funds,” the report said. “ Investors need to be made to look beyond the traditional avenues of investment through sensitization and education. In addition, campaigns should be tailored to increase the visibility of debt funds which generally tend to be safer than equity funds.”
On the supply side the report finds that mutual fund houses are not doing enough in terms of expanding their distribution beyond the top 15 cities as 89.7 per cent of all the distribution cost by AMCs is incurred in the top 15 cities and their corresponding districts itself, leaving very little for the rest of the country.
It was also noted that the mutual fund industry has only 52,000 ARN (AMFI Registration Number) holders out of which 48,000 are individual ARN holders and 4,000 are corporate ARN holders, however only 18 per cent of them are currently active. This is substantially lower to the 2.5 million agents that the insurance industry has.
The concentration of independent financial advisers is also more in the top cities with 65 per cent of the independent financial advisers (IFAs) in districts forming the first decile and approximately.
“If the reach has to be increased to tier II and tier III cities, the distribution network needs to be overhauled and innovative incentive structures need to be adopted,” said the report while stating that the insurance agents earn up to 35 per cent commission on the premium for signing up of a new customer.
Return on distribution spend?
While a large number of distributors are in few cities, the overcrowding is leading to some inefficiency. The report points out that districts in the 2nd to 4th decile generate a higher return in terms of AUM on every rupee that is spent on distribution. While one rupee spend in a top decile district would earn a fund house an average of Rs 270 in AUM, the same if spent in 2nd decile would earn an average of Rs 355 in terms of AUM.
“Due to the untapped potential of these districts, distribution networks in this decile are 31.5 per cent more efficient than the top decile. The corresponding figures for the 3rd and 4th deciles are 21.3 per cent and 12.3 per cent respectively,” the report pointed out.
What do fund managers say
When fund houses were asked questions on their scarce presence outside top 15 cities they reasoned it to lack of good talent for training and lack of investor awareness and financial sophistication.
While quality of distributors continues to present a challenge, fund houses feel that due to the current regulations that impose a limit on the incentives, good quality distributors are hard to find.
“Finding quality distributors especially in small towns and rural areas is a major hurdle towards increasing mutual fund penetration. This problem is more prevalent in case of AMCs with relatively lower AUM levels,” the fund managers feel, pointed out the report.
Some fund houses feel that mis-selling by the distributors is a major factor affecting the penetration.
In a bid to revive the same, fund houses have called for not just tax incentives but also have suggested to carry out distribution through post offices. While they demanded fiscal incentives for opening branches beyond top 15 cities, some of them even suggested to make the offence of mis-selling more stringently punishable. They even called for use of technology to increase reach and also called for better utilisation of the network of stock brokers.
The report concludes that the commissions offered to mutual fund distributors are very low and mutual fund agents outside top 15 cities cannot rely exclusively on the sale of mutual funds as an income source. Low commissions could also be a reason for the difficulty in finding talent.
The report recommended that while AMCs face difficulty in recruiting right distributors and agents in small towns and villages, they should tap on the large pool of over 1,95,000 business correspondents (as on March 31, 2013).
MFs need to utilise the banking channels more as they are underutilised. With new banks on the anvil, AMCs should start focussing on their bank distribution channels.
While deduction of “trail commission” from investors makes mutual funds less attractive, MF’s can explore the option of sharing the trail commission between fund houses and investors.
Sebi and Amfi (the newly appointed self regulatory organisation) will have to work towards overcoming these challenges and laying a roadmap for a deeper penetration of mutual funds in the country.