CHAPTER III

MUTUAL FUND INDUSTRY IN INDIA

3.1. Introduction

India is the fifth largest economy in the world and it ranks above

France, Italy, the United Kingdom, and Russia. It has the third largest GDP in

Asia. It is the second largest of the emerging nations. India is also one of the few

markets in the world which offer high prospects of growth and earning potential

in all sectors of business. The Indian capital market has been increasing

tremendously during last few years. With the reforms of economy, reforms of

industrial policy, public sector, and the financial sector, the economy has been

opened up and many developments have been taking place in the Indian capital

market. In order to help the small investors, mutual fund industry has come and

occupies an important place1. A mutual fund is a trust or an investment company

that pools resources from thousands of investors who share investment goals and

then diversifies its investment into different types of securities in order to provide

1. Nalini Prava Tripathy, (1997), Mutual Fund in India A financial service in Capital Market,

edited by Mathur B.L., Changing Profile of Financial Services, Discovery Publishing

House, New Delhi, p.21.

50

potential returns and reasonable safety. The emergence and rapid growth of

mutual fund can be described to the diversified dimension of the Indian capital

market. It has become a major vehicle for the mobilization of savings, especially

from small and house hold savers for investments in capital market. Indian

households started allocating more of their savings into the capital markets in

1980s, with investments flowing into equity and debt instruments, besides the

conventional mode of bank deposits. Until 1992, primary market investors were

effectively assured good returns as the issue price of new equity shares was

controlled and low. After introduction of free pricing of shares, new issue prices

were higher and with greater volatility in the stock markets, many investors who

bought highly priced shares lost money. Even those investors who continued as

direct investors in the stock markets realized that the key to successful investing

in the capital markets lay in building diversified portfolio, which in turn required

substantial capital. Besides, selecting securities with growth and income

potential from the capital market involved careful research and monitoring of the

market, which was not possible for all investors. Various scams in stock market

like Harsheth Metha , Ketan Parek, Satyam Computers etc reduced the

confidence of investors those who are directly invest in shares. Under these

circumstances mutual funds are the best alternative investment to direct

investment in capital market.

3.2. History of Mutual Fund in India

The mutual fund industry in India started in 1963 with the

formation of Unit Trust of India, at the initiative of the government of India and

51

Reserve Bank of India. The history of mutual funds in India can be broadly

divided into four distinct phases.

3.2.1. First Phase – The Monolithic Phase (1964-87)

Unit Trust of India (UTI) was established on 1963 by an Act of

parliament. It was set up by the Reserve Bank of India and functioned under the

regulatory and administrative control of the Reserve Bank of India. In 1978 UTI

was de-linked from the RBI and the Industrial Development Bank of India (IDBI)

took over the regulatory and administrative control in place of RBI. The first

scheme launched by UTI was Unit Scheme 1964 (US-64), which attracted the

largest number of investors in any single investment scheme over the years. UTI

launched more innovative schemes in 1970s and 80s to suit the needs of different

investors. It launched ULIP in 1971, six more schemes between 1981-84,

Children's gift growth fund and India fund (India's first offshore fund) in 1986,

Master share (India’s first equity diversified scheme) in 1987 and monthly

income schemes (offering assured returns) during 1990s. By the end of 1987,

UTI's assets under management grew ten times to ` 6700 crores2.

3.2.2 Second Phase – 1987-1993 (Entry of Public Sector Funds)

The Indian capital market had undergone an unprecedented

transformation in its over 100 years history by the end of 1987. This year marked

the entry of non- UTI, public sector mutual funds set up by public sector banks

and Life Insurance Corporation of India (LIC) and General Insurance Corporation

of India (GIC). SBI mutual fund was the first non- UTI mutual fund established

in June 1987 followed by Canbank mutual fund (Dec 87), Punjab National Bank

2. AMFI Mutual Fund Work Book, p.7.

52

mutual fund (Aug 89), Indian Bank mutual fund (Nov 89), Bank of India (Jun

90), Bank of Baroda mutual fund (Oct 92). LIC established its mutual fund in

June 1989 while GIC had set up its mutual fund in December 1990. At the end of

1993, the mutual fund industry had assets under management of ` 47,004 crores.

From 1987 to 1992-93, the fund industry expanded nearly seven times in terms of

asset under management. However, UTI remained to be the leader with about 80

per cent market share.

3.2.3. Third Phase – 1993-2003 (Entry of Private Sector Funds)

A new era in the mutual fund industry began with the permission

granted for the entry of private sector funds in 1993, giving the Indian investors a

wider choice of fund families and increasing competition for the existing public

sector funds. Also, 1993 was the year in which the first mutual fund regulations

came into being, under which all mutual funds, except UTI were to be registered

and governed. The erstwhile Kothari Pioneer (now merged with Franklin

Templeton) was the first private sector mutual fund registered in July 1993. The

1993 SEBI (Mutual Fund) regulations were substituted by a more comprehensive

and revised mutual fund regulations in 1996. The industry now functions under

the SEBI (Mutual Fund) regulations 1996. The number of mutual fund houses

went on increasing, with many foreign mutual funds setting up funds in India and

also the industry has witnessed several mergers and acquisitions. As at the end of

January 2003, there were 33 mutual funds with total assets of ` 1,21,805 crores.

The Unit Trust of India with ` 44,541 crores of assets under management was

way ahead of other mutual funds.

53

3.2.4. Fourth Phase – since February 2003

In February 2003, following the repeal of the Unit Trust of India

Act 1963 UTI was bifurcated into two separate entities. One is the specified

undertaking of the Unit Trust of India with assets under management of ` 29,835

crores as at the end of January 2003, representing broadly, the assets of US 64

scheme, assured return and certain other schemes. The specified undertaking of

Unit Trust of India, functioning under an administrator and under the rules

framed by government of India and does not come under the purview of the

mutual fund regulations. The second is the UTI Mutual Fund, sponsored by SBI,

PNB, BOB and LIC. It is registered with SEBI and functions under the mutual

fund regulations. With the bifurcation of the erstwhile UTI which had in March

2000 more than ` 76,000 crores of assets under management. In 2007, mutual

funds were permitted to introduce gold exchange funds and also the guidelines

for ‘Capital Protection oriented scheme’ were notified by SEBI. As on March

31st 2010, the total AUM is ` 614545.98 crores.

3.3. Management of Mutual Funds in India

A mutual Fund is set up in the form of a trust. The three tier

structure of mutual fund is as follows:

• Sponsor

• Trustee Company/Board of Trustees

• Asset Management Company

3.3.1. Sponsor

Every mutual fund has a sponsor. The trust is established by a

sponsor or more than one sponsor who is like the promoter of the company. The

54

sponsor establishes the mutual fund and registers it with SEBI. He also appoints

the trustees, the custodian and the asset management company in accordance with

SEBI regulations. The sponsor has to contribute at least 40 per cent of the net

worth of the AMC3. For example, for SBI Magnum, the sponsor is the State

Bank of India.

3.3.2. Trustee

The trustees of the mutual fund hold its property for the benefit of

the unit holders. They are the first level regulators of the mutual fund and are

governed by the provisions of Indian Trust Act 1908. It is the responsibility of the

trustees to protect the interest of investors whose fund is managed by the AMC.

Trustees must ensure that the transaction of the mutual fund is in accordance with

the trust deed. Trustees must furnish to SEBI, on half yearly basis, a report on the

activities of the AMC4.

3.3.3. The AMC

The investment manager in a mutual fund is technically known as

asset management company5

. The trustees appoint the asset management

company (AMC) with the prior approval of the SEBI. The AMC is a company

formed and registered under the Companies Act 1956, to manage the affairs of

the mutual fund and operate the schemes of such mutual funds. It charges a fee

3. Madhu Sinha, (2008), Financial Planning: A Ready Reckoner, Tata McGraw Hill Limited,

New Delhi, p.201.

4. Sasidharan, Alex K Mathews, (2008), Financial Services and System, Tata McGraw- Hill

Limited, New Delhi, p.311.

5. Gurusamy, (2009), Indian Financial System, Tata McGraw-Hill Education Private Limited,

New Delhi, p.203.

55

for the services it renders to the mutual fund trust. It acts as the investment

manager to the trust under the supervision and direction of the trustees.

3.4. Regulatory Framework of Mutual Funds

The Indian mutual fund industry in terms of regulatory framework

is believed to match up to the most developed markets globally. In the year 1992

Securities and Exchange Board of India (SEBI) Act was passed. The objectives

of SEBI are to protect the interest of the investors in securities and to promote the

development of and to regulate the securities market. SEBI has consistently

introduced several regulatory measures and amendments aimed at protecting the

interests of the small investor that augurs well for the long term growth of the

industry.

As far as mutual funds are concerned SEBI formulates policies

and regulates the mutual funds to protect the interest of investors SEBI notified

regulations for the mutual funds in 1993. Thereafter mutual funds sponsored by

private sector entities were allowed to enter the capital market. The regulations

were fully revised in 1996 and have been amended thereafter from time to time

SEBI has also issued guidelines to the mutual funds from time to time to protect

the interest of investors.

The Association of Mutual Funds in India (AMFI) reassures the

investors in units of mutual funds that the mutual funds function within the strict

regulatory framework. Its objective is to increase public awareness of the mutual

fund industry. AMFI also is engaged in upgrading professional standards and in

promoting best industry practices in diverse areas such as valuation, disclosure,

transparency etc.

56

The implementation of Prevention of Money Laundering (PMLA)

rules, the latest guidelines issued in December 2008 as part of the risk

management practices and procedures is expected to gain further momentum. The

current Anti Money Laundering (AML) and Combating Financing of Terrorism

(CFT) measures cover two main aspects of Know Your Customer (KYC) and

suspicious transaction monitoring and reporting.

3.5. Industry Structure

The Indian mutual fund industry currently consists of 39 players

that have been given regulatory approval by SEBI. The industry has witnessed a

shift that has changed drastically in favour of private sector players as the number

of public sector players reduced from 11 in 2001 to 5 in 2009.

3.6. Growth of Mutual Fund Industry

Growth of mutual fund industry is based on the growth of AUM ,

mobilisation of resources by mutual funds, trend in stock market, performance of

sensex , unit holding pattern etc.

3.6.1. Growth of Asset under Management

The mutual fund industry in India has grown fast in recent years.

The performance is cheering compared with advanced countries6. Today a corpus

of ` 614545 crores is being managed by nearly 882 various mutual fund schemes.

6. Ingle, (2008), ‘Mutual Funds: The Opportunity for Retail Investors’, Facts For You,

February, Vol.30(5), p.27.

57

TABLE 3.1

GROWTH OF AUM

Year AUM (in Crores)

2000 107946

2001 90587

2002 100594

2003 109299

2004 139616

2005 149600

2006 231862

2007 326292

2008 505152

2009 417300

2010 613979

Source: AMFI.

The Indian mutual fund industry is undergoing a metamorphosis,

which inadvertently marks a point of inflection for the market participants.

However, even amidst volatile market conditions, average assets under

management indicated vibrant growth levels posting a y-o-y growth of 47 per

cent in 2010, and the total AUM stood at ` 613,979 crore, as of March 31, 2010.

58

FIGURE 3.1

GROWTH OF AUM (in crores)

The above chart clearly shows the fast and steady growth of

AUM. The growth Asset under management (AUM) can also be evaluated with

the help of compound growth rate. The compound growth of Asset Under

Management from 2000 to 2010 is 16.94 per cent.

3.6.2. Mobilisation of Resources by Mutual Funds

Mutual funds play an important role in mobilising the household

savings for deployment in capital markets. The gross mobilisation of resources by

all mutual funds during 2009-10 was at `1,00,19,022 crore compared to

` 54,26,353 crore during the previous year indicating an increase of 84.7 percent

over the previous year (Table 3.2). Redemption also rose by 82.2 percent to

` 99,35,942 crore in 2009-10 from ` 54,54,650 crore in 2008-09. All mutual

funds, put together, recorded a net inflow of ` 83,080 crore in 2009-10 as

0

107946

90587

100594

109299

139616

149600

231862

326292

505152

417300

613979

0

100000

200000

300000

400000

500000

600000

700000

Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

59

compared to an outflow of `28,296 crore in 2008-09. The assets under

management by all mutual funds increased by 47.2 percent to ` 6,13,979 crore at

the end of March 2010 from ` 4,17,300 crore at the end of March 2009.

TABLE 3.2

MOBILISATION OF RESOURCES BY MUTUAL FUNDS

Source: SEBI annual report 2009-10.

Period Gross

mobilization Redemption Net Inflow

Assets at the End of

Period

1999-00 61,241 42,271 18,970 1,07,946

2000-01 92,957 83,829 9,128 90,587

2001-02 1,64,523 1,57,348 7,175 1,00,594

2002-03 3,14,706 3,10,510 4,196 1,09,299

2003-04 5,90,190 5,43,381 46,808 1,39,616

2004-05 8,39,708 8,37,508 2,200 1,49,600

2005-06 10,98,149 10,45,370 52,779 2,31,862

2006-07 19,38,493 18,44,508 93,985 3,26,292

2007-08 44,64,376 43,10,575 1,53,802 5,05,152

2008-09 54,26,353 54,54,650 -28,296 4,17,300

2009-10 1,00,19,022 99,35,942 83,080 6,13,979

TA

BL

E 3

.3

SE

CT

OR

-WIS

E R

ES

OU

RC

E M

OB

ILIS

AT

ION

BY

MU

TU

AL

FU

ND

S D

UR

ING

2009

-10

Pa

rtic

ula

rs

Priv

ate

Sec

tor M

Fs

Pu

bli

c S

ecto

r M

Fs

UT

I M

F

Open-

ended

Close-

ended

Interval

Total

Open-

ended

Close-

ended

Interval

Total

Open-

ended

Close-

ended

Interval

Total

1

2

3

4

5

6

7

8

9

10

1

1

12

13

Mobil

isat

ion

of

Funds

Repurc

has

es/

Redem

pti

on

Am

ount

Net

In

flow

/

Outf

low

of

Funds

76,6

3,1

86

(41,6

2,2

68)

75,8

5,9

14

(41,4

5,9

12)

77,2

72

(16,3

56)

22,6

46

(87,3

04)

54,6

43

(1,1

7,3

32)

-31,9

97

(-30,0

28)

12,6

51

(43,1

78)

29,9

9

(63,5

24)

9,6

53

(-2

0,3

46

)

76,9

8,4

83

(42,9

2,7

50)

76,4

3,5

55

(43,2

6,7

68)

54,9

28

(-34,0

18)

14,3

6,6

38

(6,8

8,6

52)

14,2

1,7

98

(6,7

8,2

00)

14,8

40

(10,4

51)

1,4

77

(17,7

90)

4,1

42

(18,8

54)

-2,6

65

(-1,0

64)

57

3

(4,0

30)

24

9

(4,0

37)

32

4

(-7)

14,3

8,6

88

(7,1

0,4

72)

14,2

6,1

89

(7,0

1,0

92)

12,4

99

(9,3

80)

8,7

6,5

39

(4,1

0,5

09)

8,6

2,0

24

(4,0

9,1

89)

14,5

15

(1,3

20)

1,4

28

(5,9

13)

2,8

98

(9,0

12)

-1,4

70

(-3,0

99)

3,8

84

(6,7

08)

1,2

76

(8,5

88)

2,6

08

(-1,8

80)

8,8

1,8

51

(4,2

3,1

31)

8,6

6,1

98

(4,2

6,7

90)

15,6

53

(-3,6

59)

Sou

rce:

SE

BI

An

nu

al

Rep

ort

2009-1

0.

61

Unlike the previous year, private sector mutual funds dominated

resource mobilisation efforts during 2009-10. In fact the net inflow was the

highest from private sector mutual funds at ` 54,928 crore as against a net

outflow of ` 34,018 crore in 2008-09 (Table 3.3). UTI mutual fund recorded a net

inflow of ` 15,653 crore compared to net outflow of ` 3,659 crore in 2008-09.

Net inflows were recorded by public sector mutual funds in 2009-10 amounting

to ` 12,499 crore compared to ` 9,380 crore in the previous year. While all the

open- ended and interval schemes of mutual funds recorded positive net inflows,

the close-ended schemes witnessed net outflows during the financial year. Gross

mobilisation of resources under open-ended schemes during 2009-10 was

` 99,76,363 crore, of which, about 76.8 percent was raised by the private sector

mutual funds followed by public sector funds (14.4 percent) and UTI mutual fund

(8.8 percent). Similarly, gross resources mobilised under close-ended schemes

stood at ` 25,551 crore in 2009-10, of which private sector accounted for 88.6

percent followed by public sector funds (5.8 percent) and UTI mutual fund

(5.6 percent).

62

TABLE 3.4

SCHEME-WISE RESOURCE MOBILISATION AND ASSETS UNDER

MANAGEMENT BY MUTUAL FUNDS AS ON MARCH 31, 2010

Schemes

Numbe

r of

Sche-

mes

Gross

fund

moblised

Redemp-

tion

Net

Inflow/Out

flow

Cumulative

AUM as on

31st March

2010

Percentage

Variation

over 31st

March

2009

A. Income/Debt oriented schemes

i)Liquid

/Money

market 56 7044818 7056891 -12074 78094 -13.8

ii)Gilt 35 3974 7271 -3297 3395 -47.06

iii)Debt 367 2895901 2799323 96578 311715 57.96

Sub Total

(i+ii+iii) 458 9944693 9863483 81208 393204 33.58

2008-09 (-599) (53,83,367)

(54,15,528) (-32,161)

(2,94,349) (-5.96)

B. Growth /Equity oriented Schemes

i)ELSS 48 3600 2047 1554 24066 93.64

ii)Others 307 61114 60519 595 174055 81.66

Sub Total

(i+ii) 355 64714 62566 2149 198121 83.03

2008-09 (-340) (-32805) (-28781) (-4024) (-108244) (-37.34)

C. Balanced Schemes

i)Balanced

Schemes 33 4693 5386 -693 17246 62.25

2008-09 (-35) (-2695) (-2634) (-61) (-10629) (-34.72)

D. Exchange Traded Fund

i) Gold

ETF 7 997 194 803 1590 116.06

ii) Other

ETF's 14 2538 2558 -20 957 44.94

Sub Total

(i+ii) 21 3535 2752 783 2547 82.43

2008-09 (17) (-5719) (-6718) (-998) (-1396) (-55.4)

E. Fund of Funds Investing Overseas

i) Fund of

Funds

Investing

Overseas 15 1387 1754 -367 2862 6.74

2008-09 (10) (1767) (989) (778) (2681) -

Total

(A+B+C+

D+E) 882 10019023 9935943 83080 613979 47.13

(1001) (5456353) (5454650) (-28296) (417300) (-17.39)

Source: SEBI Annual Report 2009-10.

63

Scheme-wise pattern reveals the domination of income/debt

oriented schemes in total resource mobilisation during 2009-10 (Table 3.4).

During 2009-10, there was net outflow from balanced schemes and fund of funds

investing overseas. Under income/ debt oriented schemes, gilt funds and money

market funds recorded net outflows. Even though growth/equity oriented

schemes recorded net inflows, it was substantially less compared to that in the

last year. The net amount mobilised by growth/equity oriented schemes was

` 2,149 crore in 2009-10 as compared to ` 4,024 crores mobilised in the previous

financial year. Net resources mobilised by exchange traded funds (ETFs) were

positive during 2009-10. Moreover, gold ETFs recorded multifold growth by

growing from ` 84 crore in 2008-09 to ` 803 crore in 2009-10. Fund of funds

which invest overseas also witnessed a net outflow of `367 crore as compared to

a net inflow of ` 778 crore in 2008-09. The assets under management (AUM) of

all the mutual funds increased to ` 6,13,979 crore at the end of March 31, 2010

from ` 4,17,300 crore a year ago. Assets managed by most categories of mutual

funds increased in 2009-10. The AUM was the highest for income/debt oriented

schemes at ` 3,93,204 crore while the AUM under growth/equity oriented

scheme was ` 1,98,121 crore. In terms of growth in AUM, gold ETFs (116.1

percent) achieved the highest increase followed by ELSS schemes (93.7 percent)

during the year.

3.6.3. Trends in Transactions on Stock Exchanges by Mutual Funds

The mutual funds were one of the major investors in the debt

segment of the Indian securities market. During 2009-10, the combined net

64

investments by the mutual funds in debt and equity was ` 1, 70,076 crore

compared to ` 88, 787 crore in 2008-09, registering an increase of 91.5 percent

(Table 3.5). Mutual funds were net sellers in equity segment with ` 10,512 crore,

whereas, their net investments in the debt segment rose by ` 1,80,588 crore

during the same period. The combined net investment was positive for all months

in 2009-10 except March 2010.

TABLE 3.5

TRENDS IN TRANSACTIONS ON STOCK EXCHANGES

BY MUTUAL FUNDS

(` in crores)

Year

Equity Debt Total

Gross

Pur-

chase

Gross

Sales

Sales

Net

Pur-

chase

Gross

Pur-

chase

Gross

Sales

Sales

Net

Pur-

chase

Gross

Pur-

chase

Gross

Sales

Sales

Net

Pur-

chase

2000-01 17376 20143 -2767 13512 8489 5023 30888 28631 2257

2001-02 12098 15894 -3796 33557 22594 10963 45655 38488 7167

2002-03 14521 16588 -2067 46664 34059 12604 61185 50647 10538

2003-04 36664 35356 1308 63170 40469 22701 99834 75825 24009

2004-05 45045 44597 448 62186 45199 16987 107232 89796 17435

2005-06 100436 86133 14303 109720 72969 36801 210202 159102 51104

2006-07 135948 126886 9062 153733 101190 52543 289681 228075 61606

2007-08 217578 201274 16306 298605 224816 73790 516183 426090 90095

2008-09 144069 137085 6984 327744 245942 81803 471815 383026 88787

2009-10 195662 206173 -10512 624314 443728 180588 819976 649901 170076

Source: SEBI Hand Book 2010.

65

TABLE 3.6

UNIT HOLDING PATTERN OF PRIVATE AND PUBLIC SECTOR

MUTUAL FUNDS AS ON MARCH 31, 2010

Category

% to total

Investor

Accounts

% to Total

Net Assets

Private Sector Mutual Funds

Individuals 96.24 39.74

NRIs 2.52 5.13

FIIs Corporate / Institutions/ 0.00 1.29

Others 1.24 53.84

Total 100 100

Public Sector Mutual Funds including UTI MF)

Individuals 98.65 39.90

NRIs 0.95 2.00

FIIs 0.00 0.10

Corporate/ Institutions/ Others 0.40 58.00

Total 100 100

Source: SEBI Annual Report 2009-10.

The unit holding pattern of public and private sector mutual

funds as on March 31, 2010 shows the dominance of private sector mutual

funds in the number of investor accounts as well as share in net assets (Table

3.6). The private sector mutual funds had 65.4 percent of the total

investors account compared to 34.6 percent in public sector mutual funds.

The private sector mutual funds managed 77.9 percent of the net assets as

against 22.1 percent of net assets managed by public sector mutual funds.

While individual investors held 39.9 percent of the net assets in public sector

66

mutual funds, their share in private sector mutual funds was 39.7 percent as

on March 31, 2010.

3.6.5. Comparison of Indian Capital Market (Sensex) Vs Mutual Fund

Industry (AUM)

Mutual fund is a part of capital market. The changes in the capital

market reflect the performance of mutual funds especially in equity funds. The

growth of sensex (it is an index which shows the performance of Bombay share

market) and AUM is given below.

TABLE 3.7

SENSEX Vs AUM

Year Sensex AUM (in Crores)

1999-00 3455 107946

2000-01 4905 90587

2001-02 3481 100594

2002-03 3435 109299

2003-04 3037 139616

2004-05 5809 149600

2005-06 6379 231862

2006-07 11742 326292

2007-08 13478 505152

2008-09 16291 417300

2009-10 17559 613979

Source: AMFI and BSE.

In the year 1999-2000, Sensex value was 3455 and AUM was

107946 crs. In 2005-2006, Sensex was 6379 and AUM was 231862 crs. It was

raised in the year 2009-2010, Sensex was 17559 and AUM was 613978 crs.

67

The growth of sensex and AUM can also be evaluated with the

help of compound growth rate. The compound growth of Asset under

Management from 2000 to 2010 is16.97 per cent and sensex is15.76 percent. It

shows the performance of AUM overtake sensex value.

3.7. Challenges of Mutual Fund Industry in India

There are continuing concerns that the industry has been grappling

with over a considerable period of time.

3.7.1. Low Levels of Customer Awareness

Low customer awareness levels and financial literacy pose the

biggest challenge to channelizing household savings into mutual funds. IIMS

works data released in 2007 establishes that low awareness levels among retail

investors has a direct bearing on the low mutual fund off take in the retail

segment. The general lack of understanding of mutual fund products amongst

Indian investors is pervasive in metros and tier 2 cities alike and majority of them

draw little distinction in their approach to investing in mutual funds and direct

stock market investments. A large majority of retail investors lack an

understanding of risk-return, asset allocation and portfolio diversification

concepts. Low awareness of SIPs in India has resulted in a majority of the

customers investing in a lump sum manner.

3.7.2. Limited Focus on Increasing Retail Penetration

The Indian mutual fund industry had limited focus on building

retail AUM and has only recently stepped up efforts to augment branch presence

in tier 2 and tier 3 towns. Players have historically garnered AUM by targeting

68

the institutional segment that comprises 55 percent AUM share as at March 2010.

Large ticket size, tax arbitrage available to corporate on investing in money

market mutual funds, easy accessibility to institutional customers concentrated in

tier 1 cities are the factors instrumental in mutual fund houses focusing on the

institutional segment. Building retail AUM requires significant distribution

capability and wide foot print to operable to penetration to tier 2 and tier 3 towns,

which AMC’s have recently started focusing on. Institutional AUM, however,

makes the industry vulnerable to the possibility of sudden redemption pressures

that impact the fund performance.

3.7.3. Limited Focus beyond the Top 20 Cities

The mutual fund industry has continued to have limited

penetration beyond the top 20 cities. Cities beyond top20 only comprise

approximately 10 percent of the industry AUM as per industry practitioners.

There tail population residing in tier2 and tier 3 towns, even if aware and willing,

are unable to invest in mutual funds owing to limited access to suitable

distribution channels and investor servicing. The distribution network of most

mutual fund houses is largely focused on the top 20 cities given the high cost

associated with deeper penetration into tier 2 and tier3 towns. However, some of

the mutual fund houses have begun focusing on cities beyond the top 20 by

building their branch presence and strengthening distribution reach through non-

branch channels.

3.7.4. Limited Innovation in Product Offerings

The Indian mutual fund industry has largely been product-led and

not sufficiently customer focused. The popularity of NFOs triggered a

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proliferation of schemes with a large number of non-differentiated products. The

industry has had a limited focus on innovation and new product development,

there by catering to the limited needs of the customer. Products that cater

specifically to customer life stage needs such as education, marriage, and housing

are yet to find their way in the Indian market. The Indian mutual fund industry

offers limited investment options viz. capital guarantee products for the Indian

investors, a large majority of whom are risk averse. The Indian market is still to

witness the launch of green funds, socially responsible investments, fund of

hedge funds, enhanced money market funds, renewable and energy/climate

change funds.

3.7.5. Limited Customer Engagement

Mutual fund distributors have been facing questions on their

competence, degree of engagement with customer and the value provided to the

customer. In the absence of a frame work to regulate distributors, both the

distributors and the mutual fund houses have exhibited limited interest in

continuously engaging with customers post closure of sale as the commissions

and incentives had been largely in the form of upfront fees from product sales

(although trail commissions have also been paid in limited instances regardless of

the service rendered). As a result of the limited engagement, there have been

rising instances of mis-selling to customers.

3.7.6. Limited Focus of the Public Sector Network on Distribution of

Mutual Funds

Public sector banks with a large captive customer base, significant

reach beyond the top20 cities in semi-urban and rural areas, and the potential to

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build the retail investor base, have so far played a very limited role in mutual

funds distribution. The Indian post net work operating the largest postal network

in the world majority of which is in rural areas, is stated to have 250 post offices

selling mutual funds of five AMCs only, further most of the post offices selling

mutual funds are located in tier1 and tier2 cities which are already been catered

to, by national level and other distributors. India post with its customer base of

170 million account holders and branch network of over 154,000 branches,

doubling the size of all bank branches put together is a formidable channel which

has been underutilized to date for mutual fund distribution. The postal network

also serves as a means to facilitate inclusive and equitable growth to all regions

and social groups by providing them with access to financial products such as

mutual funds. Further the credibility enjoyed by the nationalised banks, regional

rural banks and co-operative banks in the rural hinter land has not been fully

leveraged to target there tail segment.

3.7.7. Multiple Regulatory Frameworks Governing Financial Services

Sector

The regulatory and compliance requirements vary across verticals

within the financial services sector specifically mutual funds, insurance and

pension funds each of which are governed by an independent regulatory frame

work and are competing for the same share of the customer’s wallet. The mutual

fund industry lacks a level playing field in comparison with other verticals within

the financial services sector. The mandatory PAN card requirement for investing

in mutual funds is perceived to restrict significant potential of the mutual fund

industry being able to tap small ticket investors from investing in mutual funds.

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On the other hand, ULIPs which are deemed to be competing products do not

have the mandatory PAN requirement. While the payment for investment into

mutual funds can be made only through banking facilities, the purchase of ULIPs

can be undertaken through cash. The recently introduced NPS regulations

requiring the AMCs to create a separate legal entity for pension funds

management have created an additional cost structure for the mutual fund players.

Outsourcing funds management in excess of INR80 billion by insurance

companies is not permitted and thus restricts an additional revenue opportunity

for the mutual fund industry. In summary, the challenges and issues faced by the

Indian mutual fund industry will need to be addressed at the earliest to ensure

long term sustained, profitable growth of the industry

3.8. Recent Developments in the Industry

The Indian mutual fund industry is undergoing a transformation,

adapting to the various regulatory changes that are coming about. Following are

some of the key ones which have undergone an amendment, impacting the

industry as a whole. However, all of them primarily would seem to have the

interest of the investor in mind.

3.8.1. Trading through Stock Exchange Platforms

Recently, SEBI has permitted trading of MF units on recognized

stock exchanges. Subsequently, Bombay Stock Exchange and National Stock

Exchange have launched trading platforms enabling investors to invest by

availing services of stock brokers. While trading through the stock exchange, the

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investor would get to know about the validity of his order and the value at which

the units would get credited/ redeemed to his account by the end of the day.

3.8.2. Introduction of ASBA Facility

SEBI has introduced ASBA (Applications Supported by Blocked

Amount) to investors subscribing to NFOs of mutual fund schemes, to make the

process of primary issues efficiently. ASBA is compulsory for all investors for all

NFOs launched on or after 01 July 2010. ASBA allows money to be debited from

investors account once units are allotted to them. This will help investors earn

additional interest as money will leave customers bank accounts. ASBA will

considerably reduce paper work for AMCs

3.8.3. Entry Load

In recent years, the industry regulator, Securities and Exchange

Board of India (SEBI) has focused more on investor protection, introducing a

number of regulations to empower retail investors in mutual funds. SEBI began

by prohibiting the charging of initial issue expenses, which were permitted for

closed-ended schemes, and mandating that such mutual fund schemes shall

recover sales and distribution expenses through entry load only. These steps

aimed at creating more transparency in fees paid by investors and helping make

informed investment decisions. Subsequently, w.e.f. August 1, 2009, SEBI

banned the entry load that was deducted from the invested amount, and instead

allowed customers the right to negotiate and decide commissions directly with

distributors based on investor’s assessment of various factors and related services

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to be rendered. The objective was to bring about more transparency in

commissions and encourage long-term investment.

3.8.4. Reduction of NFO Period

SEBI has reduced the NFO period to 15 days to make the NFO

process efficient. This is applicable for NFOs launched after July 2010.

However, the NFO period for equity linked savings scheme (ELSS) will continue

to be governed by guidelines issued by the government of India. Earlier, the NFO

period use to be 30 days and 45 days for open-ended and close-ended schemes

respectively except ELSS. Mutual fund house have to allot units or refund

subscription and dispatch statements of accounts within five business days from

the closure of NFO. All the schemes (except ELSS) will be available for ongoing

repurchase or sale or trading within five business days of allotment. This

initiative will make the process of NFO much faster and smoother.

3.8.5. No Additional Management Fees on Schemes Launched on “No

Load” Basis

SEBI has scrapped the additional management fee of 1 per cent

charged by AMCs on schemes launched on a no load basis leading to a further

squeeze in margins earned by the AMC.

3.8.6. Documentation

In 2009 December, SEBI had made it mandatory for all AMCs to

maintain a copy of full investor documentation including Know Your Customer

i.e. KYC details. Such documentation was earlier maintained by the respective

mutual fund distributors who have now been asked to give a copy of the same to

the fund houses.

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3.8.7. Disclosure of Investor Complaints in the Annual Report

In order to improve the transparency in the ‘grievance redressal

mechanism’, SEBI has recently issued a circular that requires mutual funds to

include details of investor complaints in their annual report as part of the report

of the trustees, beginning with the annual report for the year 2009-10. Mutual

fundss provide abridged booklets of the annual reports to all the unit holders.

3.8.9. Fund of Fund Schemes

In the past, AMCs had been entering into revenue sharing

arrangements with offshore funds in respect of investments made on behalf of

Fund of Fund (‘FOF’) schemes. Recently, SEBI has issued directions stating that

since these arrangements create conflict of interest, AMCs shall be prohibited

from entering into any revenue sharing arrangement with the underlying funds in

any manner and they have been prohibited from receiving any revenue by

whatever means/ head from the underlying fund. Further, SEBI is also in

discussions to raise the AMC fees from the present cap of 0.75% of the net assets

in the case of FOF schemes.

3.9. Future of Mutual Fund Industry in India

India is undoubtedly emerging as the next big investment

destination, riding on a high savings and investment rate, as compared to other

Asian economies. As per a report authored by PwC “The World in 2050”,the

average real GDP growth in India was likely to be in the range of 5.8 per cent

between 2007-50, (the actual average GDP growth between 2007-10 has been 7.6

per cent with per capita income rising to USD 20,000 from the current USD

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2,932. Over 50 per cent of the population is less than 25 years of age, with the

proportion of working population likely to increase significantly over the next

decade. The trend of rising personal incomes has been witnessed not only

amongst the young population, but also the high net worth (HNI) segment, which

have sizeable sums to invest. The house-hold segment therefore proffers immense

scope for attracting investments. India has a strong middle class of 250-300

million, which is expected to double over the next two decades.