CHAPTER TWO Mutual Funds: Concept, Evolution and Growthshodhganga.inflibnet.ac.in/bitstream/10603/8185/11/11... · 2018. 7. 9. · companies which cater to the specific investment

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CHAPTER TWO

Mutual Funds: Concept, Evolution and Growth

Introduction

The objectives of this chapter are: (a) to understand the

conceptual framework of mutual funds, (b) to study the historical

evolution and growth of mutual fund industry in the world, and (c) the

future outlook of MF industry. In section one; we discuss the concept,

benefits & types of MF schemes. Section 2 traces the historical

evolution and growth of MF industry, including the development

pertaining to MF industry in United Kingdom, United States and India.

Section 3 provides the future outlook of the MF industry including the

outlook of MF Industry in India. Finally, summary of this chapter is

presented in the Section four.

2.1 Conceptual Framework of Mutual Fund

We initiate our discussion by explaining the concept of mutual

fund. Next, the benefits of investing in MF schemes are discussed.

Finally, the types of MF schemes available for investors are briefly

discussed.

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2.1.1 Concept of mutual fund

Mutual fund4 company pools money from many investors who

seek the same general investment objective and invests the money in

stocks, bonds, short term money market instruments, other securities or

assets, or some combination of these investments (Mohanan, 2006).

These pooled funds provide thousands of investors with proportional

ownership of diversified portfolios managed by professional investment

managers. The term „mutual‟ is used in the sense that all its returns,

minus its expenses, are shared by the unit holders of fund. Figure 2.1

shows flow chart of MF operations. Certain investors, who do not fully

understand the intricacies of investing into the financial markets or

otherwise are not willing to be directly active in the financial markets,

may channelize their savings into the financial markets by investing into

the MF schemes.

4 "Mutual fund" means a fund established in the form of a trust to raise monies through

the sale of units to the public or a section of the public under one or more schemes for

investing in securities, including money market instruments.

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Figure 2.1

Flow chart of the MF operations

Source: amfiindia.com

2.1.2 Benefits of investing in MF schemes

The purpose of MF scheme is to make saving and investment

simple, accessible, and affordable to the retail individual investors5. The

advantages of investing in MF scheme include professional

management, diversification, variety, low cost, liquidity, convenience,

and regulatory protection.

(a) Professional management

5 According to Securities and Exchange Board of India, „retail individual investor‟

means an investor who applies or bid for securities of or for a whole value of not more

than Rs. 1,00,000/-

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The money pooled in by floating a MF scheme is managed by

fund manager(s) who decides the investment strategy on behalf of the

unit holders of the MF scheme. The avaibility of large pool of funds

provide flexibility to MF companies to hire very qualified full time fund

managers for each MF schemes. The fund managers, based on the

extensive market research invest the funds in such a way that best match

the investment objective of the schemes as described in the scheme's

prospectus6.

(b) Diversification

Diversifying the portfolio helps reduce the adverse impact of

company specific risk. The avaibility of large pool of investable fund

provides fund managers to more appropriately diversify the portfolio at a

fraction of cost which a retail investors cannot attain by themselves.

(c)Variety

Within the broad categories of stock, bonds and money market

funds, investor can choose among a variety of investment approaches.

At the end of year 2009, there were 7,691 MF schemes in United States

and 65,735 MF schemes worldwide (ICI Fact Book, 2010). In India,

where the growth in the MF industry is a recent phenomenon, as of

6 In India the word prospectus is used for MFs offer document

23

September, 2010 there were 918 MF schemes available7, with goals and

styles to fit most objective and circumstances.

(d) Low cost

The average cost of managing a rupee is much lower for MF

schemes, than for an investor managing a diversified portfolio all of her

own. The low cost are due to standardization, and high economies of

scale. In many countries regulator sets upper ceiling on the amount of

expense that can be charged from investors. Apart from the regulatory

ceilings, competition plays its own role in determining the cost of

investing through MF schemes. With the increase in the level of

maturity of the MF industry the average cost of investing through MF

schemes decreases.

(e) Liquidity

Investments in MF schemes are liquid8 in nature as they can be

sold on any business day. As per the regulatory requirement MF

7 AMFI Updates, July-September, 2010, Vol. X, Issue II. Retrieved December 10, 2010

from http://www.amfiindia.com 8 Liquid assets can be defined as assets held as cash, or in the form of securities which

can be converted into cash swiftly and with minimal capital loss

24

companies are required to buy, or redeem units of MF schemes each

business day on NAV9 related prices.

(f) Convenience

Investment in MF schemes provides investors the flexibility in

selection of distribution channel as multiple channels (for e.g. MF

agents, banks, brokers etc) are available in the market to buy and sell

MF schemes. Further, investor has the flexibility to directly buy and sell

MF schemes from the MF Company. Investor can also arrange for

automatic reinvestment of periodic distribution of the dividends and

capital gains paid by the MF schemes. Apart from this MF companies

also offer a wide variety of other services, including monthly or

quarterly accounts statement, tax information etc.

(g) Regulatory protection

To protect the interest of retail investors, MF Companies are

subject to strict regulation and oversight by the regulatory agency of the

respective countries. In India, MF companies are regulated by

SEBI10

(Mutual Fund) Regulation Act 1996.

9Net asset value (NAV) is the current market value of all the fund‟s assets, minus

current liabilities, divided by the total number of outstanding units. 10

SEBI stands for Securities and Exchange Board of India

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2.1.3 Types of MF schemes

There are various types of MF schemes offered by the MF

companies which cater to the specific investment needs of investors like

financial position, risk appetite, return expectation and life cycle etc. At

the end of September 2010, in India there were 918 MF schemes

available for the investors. AMFI11

classifies the MF schemes on the

basis of their structure as well as their objective.

On the basis of the structure, MF schemes can be categorized as

open-ended schemes, close-ended schemes and interval schemes. Open–

ended MF schemes are available for subscription all through the year.

These do not have a fixed maturity period. Investors can conveniently

buy and sell units at NAV related prices. The key feature of open-ended

scheme is liquidity. On the other hand closed-ended MF schemes have a

stipulated maturity period that ranges from three to fifteen years. The

schemes are open for subscription only during a specified period.

Investors can invest in the scheme at the time of the initial public issue

and thereafter they can buy or sell the units of the schemes from the

stock exchanges where they are listed. In order to provide an exit route

to the investors, some close-ended MF schemes gives an option of

selling back the units to the MF Company through periodic repurchase

11

AMFI stands for Association of Mutual Fund Industry in India

26

at NAV related prices. SEBI regulation requires that at least one of the

two exit routes is provided to the investor in case of close-ended

schemes in India. Interval schemes combine the features of open-ended

and close-ended MF schemes. They are open for sale or redemption

during predetermined intervals at NAV related prices.

MF schemes can also be classified on the basis of investment

objectives. AMFI classifies the schemes as growth schemes, income

schemes, balanced schemes and money market schemes. The aim of the

growth schemes is to provide capital appreciation over the medium to

long term. Such schemes normally invest a majority of their corpus in

equities. The objective of income schemes is to provide regular and

steady income to investors. Such schemes generally invest in fixed

income securities such as bonds, corporate debentures and government

securities. Income schemes are considered ideal for capital stability and

regular income. Balance schemes aims to provide both growth and

regular income to the investors. Such schemes periodically distribute a

part of their earnings and invest both in equities and fixed income

securities in the proportion indicated in their offer documents. These are

ideal for investors looking for a combination of income and moderate

growth. Money market schemes aims to provide liquidity, preservation

of capital and moderate income. These schemes generally invest in safer

27

short-term instruments such as treasury bills, certificate of deposit,

commercial paper and interbank call money. Returns on these schemes

may fluctuate depending upon the interest rates prevailing in the market.

Apart from the above two classification of the schemes offered

by MF companies, there are other schemes offered by MF companies,

catering to the investment needs of individual as well as institutional

investors. Few other schemes offered by MF companies are tax saving

schemes, industry specific schemes, index schemes, sectoral schemes,

gold traded funds (GTF), exchange traded funds (ETF), capital

protection funds etc.

2.2 Evolution and Growth of MF Industry

In this section we initiate our discussion on the evolution of MF

industry in the world. This will be followed by discussion on the

evolution and growth of MF industry in United Kingdom (UK). The

evolution and growth of MF industry in United States of America (USA)

is discussed next. Finally, the evolution and growth of MF industry in

India is discussed along with its current regulatory framework. In the

subsequent section the future outlook of MF industry will be discussed.

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2.2.1 Evolution of MF industry in the world

The evolution of MF industry can be traced back to eighteenth

century when a number of investment vehicles emerged that created a

joint interest in a pool of financial and non financial assets. Though they

were not alike the modern MFs yet they manifested many of the same

characteristics as contemporary MFs do. Their progression brings an

understanding of the first investment trusts to create tradable ownership

of a financial security portfolio.

The Dutch merchant and broker Abraham Van Ketwich in year

1974, on being incited by the financial crisis of 1772-73, invited

subscriptions from investors to form a trust named Eendragt Maakt

Magt- the maxim of the Dutch Republic, “Unity Creates Strength”

(Rouwenhorst, 2004). It endeavored to provide small investors with

limited means with an opportunity to diversify (Rouwenhorst, 2004)

which was achieved by diversifying the investments in Austria,

Denmark, Germany, Spain, Sweden, Russia and a variety of colonial

plantations in Central and South America (Rouwenhorst, 2004). This

incident represents the beginning of MFs.

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Eendragt Maakt Magt proved to be a successful venture and

subsequently, the concept was embraced by many followers. In 1776 a

consortium of Utrecht bankers laid the foundation for the negotiate

Voordeelig en Voorsigtig (Profitable and Prudent). However, this time

Abraham van Ketwich did not act as administrator but was closely

involved in the creation of the fund as the prospectus listed his office as

collection agency for periodic dividend payments (Rouwenhorst, 2004).

Abraham van Ketwich launched his second MF under the name

Concordia Res Parvae Cresunt in 1779 which was the Latin origin of

Eendragt Maakt Magt12

. Despite the fact that Van Ketwich‟s second

fund resembled his first in terms of name and structure, he chose for

more freedom in investment policy in the second one.

The eighteenth century witnessed the gradual rise of Mutual

funds with merchants and brokers learning to enlarge the scope of

investment opportunities for general public. Securitization13

and Stock

Substitution14

were the two principal innovations which were designed

to overcome barriers associated with the investment opportunities

12

Concordia res parvae crescunt, Discordia maximae dilabuntur” is attributed to the

Roman historian Sallust, meaning “In harmony small things grow, dissention dissolves

the greatest.” 13

Securitization uses the cash flows of illiquid claims as collateral for securities that

can be traded in financial markets. 14

In a stock substitution, existing securities are repackaged individually or as part of a

portfolio to make them easier to trade, either in smaller denominations or at a lower

cost than the underlying claims.

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abroad (Rouwenhorst, 2004). In due course, this broadening of the

Dutch capital market led to the introduction of the forerunners of today‟s

closed-end mutual funds and depository receipts.

The fate of early MFs was closely related to the fate of their

principal investments i.e. plantation loan in the West Indies

(Rouwenhorst, 2004). The occurrence of the Fourth English War in 1780

created troubles for colonial shipments to the Dutch commission agents,

affecting the proceeds that were pledged as the security for holders of

the plantation loans. All three funds, by the culmination of the century,

disappeared from the official published record of the Amsterdam stock

exchange, and the transaction price show up only at irregular private

auction by security brokers (Rouwenhorst, 2004). In 1799, when the

scheduled life of Eendragt Maakt Magt was to expire, participants

decided to extend the negotiate until the shares could be redeemed at par

(Rouwenhorst, 2004). In the year 1803, the firm of Van Ketwich and

Voomberg (Rouwenhorst, 2004) took over the management of the

affairs of Eendragt Maakt Magt and Concordia Res Parvae Crescunt.

The share price of Eendragt Maakt Magt touched its lowest of 25

percent of its nominal value of 500 guilders in 1811, but eventually it

recovered. The fund, phenomenally, involved itself in actively

repurchasing shares in the open market where prices were depressed

31

(Rouwenhorst, 2004). In 1824, a liquidating dividend of 561 guilders

was paid to the remaining participants. Final settlement of the shares in

Concordia Res Parvae Crescunt took substantially longer and it was

officially dissolved in 1893 after a life of 114 years (Rouwenhorst,

2004). In 1894, a final distribution of 430.55 guilders per share of 500

guilders was paid, or 87 percent of the original investment. Regardless

of the misfortunes, Concordia Res Parvae Crescunt is perhaps the

longest MF to have ever existed (Rouwenhorst, 2004).

2.2.2 Evolution and growth of MFs in United Kingdom

The first investment trusts were not able to perform well

nevertheless, it did not stop the many successful ventures which were

yet to begin. The Foreign and Colonial Government Trust, formed in

London in 1868, marked the beginning of MFs in the Anglo-Saxon

countries (Rouwenhorst, 2004). The trust aspired to give investor‟s of

moderate means, the same advantage as of the large capitalist. In UK,

the year 1880 demonstrated a period of boom for this innovative

investment opportunity. Owing to crash in UK during 1890, some

investment trusts failed but most of them survived. More than 100

investment trusts were functioning by 1900 and many of them are still

around (Rouwenhorst, 2004). These investment trusts are closed ended

32

funds. The first phase of its operation (till mid-1920s) witnessed MFs

which were in formative and experimental stage. They were

incorporated under the Companies Act. The sale and purchase of

securities vested in the investment manager who enjoyed huge powers.

There was a rising propensity of British investment managers to invest

their client funds in American securities, especially in stocks and bonds

of American Railways from 1900 to 1914 (Rouwenhorst, 2004). With

the advent of First World War, this situation changed radically and from

1914 to 1918, British MF investment managers sold a large proportion

of their American investments, and a large part of the money obtained

from the sale of American stocks and bonds was swiftly invested in the

war loans of British Government (Rouwenhorst, 2004). Despite low

returns, this strategy facilitated the continued existence of the industry

(Rouwenhorst, 2004).

The 1929 crash in the Wall Street in United States also

represents an event which had important implications for the UK mutual

fund industry. This event directed the industry to put thrust on the

process of structural changes in the MF industry in UK. The most

noteworthy structural change resulted in the emergence of the unit

33

trusts15

. The first unit trust came into existence in the year 1931, shortly

after the Wall Street crash.

The popularity of investment trust continued to increase with

private investors‟ which led to its rapid expansion till stock market crash

in October, 1987 in UK. As on January 1988, there were almost 1200

unit trusts managed by more than 160 groups (Rouwenhorst, 2004). The

acceptance of these trusts was mainly due to the range of investment

opportunities they provided to the investors. Significant changes in the

MF industry were initiated as a result of the stock market crash and one

of them was the implementation of Financial Service Act. The Financial

Service Act aimed at bringing greater protection for the investors by

developing a regulatory framework for MF industry in UK.

The MF industry has sustained its growth pattern in UK. The net

assets of MFs in U.K have shown a CAGR of 14.74 % during the year

2000 to 200716

. By the end of year 2007, there were 2057 MF schemes

with net assets of 944,536 million of US $. Presently, equity schemes

15

Unit trusts are created by a trust deed. Internationally, mutual fund can be set up

either as companies or as trusts. In the company form, the investor became the

shareholders; in the trust form, the investor became the beneficial owner of the trust. 16

ICI Fact Book , 2008. Retrieved February 12, 2009 from http://www.icifactbook.org

34

dominate the asset structure of MFs in UK with 52%, followed by fixed

income schemes 32% and money market MF schemes 9 %.

2.2.3 Evolution of MFs in United States of America

The origin of MF in the United States of America (USA) could

be traced to the private trustee system in Boston during the second half

of 19th

century17

.One of the first investment trusts, the Boston Personal

Property Trust, was constituted in 189318

. It advertized that it “was

organized for the purpose of giving persons of small means an

opportunity to invest in diversified lists of securities held by a trusts”

which was managed by professional trustees which is a regular line of

business in Boston. It was the Alexander fund established in

Philadelphia in 1907 by W. Wallace Alexander that seems to have

originated many of the ideas adopted by MFs. As the US economy

continued to grow, investment companies were formed in Boston, New

York and many other states.

17

The rise of the Boston trustee was in a large part due to a decision of a U.S court in a

case involving Harvard College and Mrs. And Mr. Amory in 1830. The judge ruled:

“Do what you will all that can be required of a trustee is that he shall conduct himself

faithfully and exercise a sound discretion. He is to observe how men of prudence,

discretion, and intelligence manage their own affairs, not in regard to speculation, but

in regard to permanent disposition of their funds, considering the probable income as

well as the probable safety of the capital to be invested” 18

Significant Events in the Fund History, Retrieved December 10, 2009 from

http://www.icifactbook.org

35

The evolution of MF industry in US may be divided into three

phases. Year prior to 1940 is marked for the evolution and development

of MF industry (first phase). Second phase includes the year from 1940

to 1970. During these years MF industry witnessed rapid and steady

growth and evolved into an established industry. The third phase in the

evolution of MF industry in U.S (i.e. from the year 1970 to present) has

been primarily witnessing innovation in products and services being

offered to the investors19

.

The first phase (i.e. prior to year 1940) was the stage of infancy

for the MF industry in US. MFs in those days were small and dissimilar

to the extent that these entities were not given the status of separate

industry. Closed ended funds were the dominant form of MF to mobilize

money20

. However by the end of 1940s the share of close ended funds

started shrinking in favor of open ended funds. A major regulatory

development took place in the year 1933 when “The Security Act” came

into existence21

. The purpose of the act was to put regulatory framework

19



20

In the year 1929, assets mobilized under closed ended schemes accounted for 95 %

of the total assets of the industry. 21



36

in place with respect to registration and offering of new securities,

including mutual fund and closed end fund shares to the public. In the

year 1934, The Security Exchange Act authorized the security exchange

commission (SEC) to provide for fair and equitable security markets.

Subsequently, “The revenue act of 1936” established the tax treatment

of MFs and their shareholders22

. Closed ended fund was covered by the

Act in the year 194223

.

In the second phase, assets managed by MFs witnessed rapid and

steady growth and MF evolved into an established industry. In this phase

open ended fund became the dominant form of MF schemes. In the year,

1940 “the Investment Company Act of 1940” was signed into law,

setting the structure and regulatory framework for registered investment

companies24

. MF industry was growing steadily and in the year 1951,

for the first time the total number of mutual funds surpassed 100, and the

number of shareholder accounts exceeded one million25

. This growth in

shareholders account also put impetus to the growth in innovation by

MF companies. In the year 1955, first U.S- based international MF was

22


http://www.icifactbook.org 23







37

introduced. In the year 1961, first tax- free investment trust was offered.

MF industry received a major boost with the introduction of “The Self-

Employed Individual Tax Retirement Act, which created saving

opportunities (Keogh Plan) for self employed individuals26

.

The most striking feature of the third phase (i.e. from 1970 to

present) is the innovations in the investment objectives of MFs. Till this

phase most of the money were mobilized under the objective of

providing the benefit of diversification in equity investing. While there

were five types of fund in offer in 1970, there were twenty two different

types in the year 1987. Introduction of money market MF in the year

1971 is considered most innovative product offered by MF companies in

recent times. This was due to the fact that this product was in quite

contrast to the existing products and in many ways, was very similar to

the product offered by banks. This expanded the scope of competition

for MFs with bank on account of similarity in the product. The first

retail index fund was offered in the year 197627

. MF industry continued

to grow and in the year 1989 MF assets top $ 1 trillion28

. Enactment of

the National Securities Markets Improvement Act of 1996 (NSMIA)

26







38

provided a more rational system of state and federal regulation, giving

the SEC exclusive jurisdiction for registering and regulating mutual

funds, exchange listed securities, and larger advisers. States retained

their antifraud authority and responsibility for regulating non-exchange

listed offerings and smaller advisers29

. In the year 1998, the SEC

approves the most significant disclosure reforms in the history of U.S.

mutual funds, encompassing “plain English,” fund profiles, and

improved risk disclosure.

Another important development during this phase is the

innovative steps taken up by MF companies to improve the quality of

investor service. In the year 1999, The Gramm-Leach-Bliley Act

modernized financial services regulation and enhanced financial

privacy30

. In the same year Investment Company Institute (ICI)

published a report on the best practices for fund directors31

. However,

year 2003 was marked with the evidence of wide spread illegal trading

schemes, late trading, and market timing that potentially cost MF

shareholders billions of dollars annually. SEC claimed that certain MF

companies alerted favored customers or partners when one or more of a

29







39

company‟s funds planned to buy or sell a large stock position and were

engaged in insider trading. This resulted in the resignation of key

personals of major MF companies and heavy penalties were charged

against MF companies found engaged in illegal activity. In order to

avoid the similar problems of poor governance among MF companies,

the independent director council was formed in the year 2004 to address

the growing complexity of fund governance responsibility.

Despite the 2003 MF scandal and global financial crisis of 2008-

09, the story of MF industry is far from over. In U.S there are more than

10,000 MFs with fund holdings of trillions dollars32

. Due to continuous

launch of new and innovative products, MF industry in U.S remains

healthy and fund ownership continues to grow.

2.2.4 Evolution of MFs in India

In this section first, the evolution and growth of Indian MF

industry is discussed which is followed by discussion on the regulatory

framework for Indian MF industry .

2.2.4.1 Evolution of MF industry in India

32

ICI Fact Book, 2008. Retrieved February 12, 2009 from http://www.icifactbook.org

40

In India, evolution of MF industry can be categorized into four

phases. The first phase during the years 1963-1987 saw Unit Trust of

India consolidating its position by offering a variety of products and

extending its reach throughout the country. The next phase (1987-93)

marked the arrival of MFs sponsored by public sector banks and

financial institutions. The third phase began in 1993 with the arrival of

private sector players, both Indian and foreign. The fourth phase started

with SEBI (Mutual Fund) Regulations, 199633

.

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 purpose of establishing the

UTI was to give a fillip to the equity market. In the wake of the Indo-

China war in 1961, there was shortage of savings going into industrial

investments for economic development. There was a need to mobilize

adequate amount of risk capital for industrial enterprises (Indian

Institute of Banking & Finance, 2004). The first scheme launched by

33

History of the Indian MF industry. Retrieved December 10, 2009 from

http://www.amfiindia.com

41

UTI was Unit Scheme 1964. In the initial years, the emphasis in UTI

was on income funds. Master share launched in the year 1986 mark the

beginning of equity oriented MF schemes in India. Gradually, UTI

launched a variety of innovative products suited to meet diverse needs of

investors, virtually covering the complete life cycle of an investor. At

the end of 1988, UTI had Rs.6, 700 crores of assets under

management34

.

In the year 1986, public sector banks and financial institutions

were given permission to establish MFs. State Bank of India (SBI)

established the first MF. SBI preferred to adopt the trust route and set up

the MF as a trust under the Indian Trust Act, 188235

. This choice was

purely accidental. Other MFs also followed the SBI model. The trust

form under the Indian Trust Act came to be the accepted legal form of

MFs in India36

.Thereafter many MFs were established like Canara Bank

in December 1987, Punjab National Bank Mutual Fund in August 89,

Indian Bank Mutual Fund in November 89, Bank of India in June 90,

and Bank of Baroda Mutual Fund in October 92. Life Insurance

34


http://www.amfiindia.com 35

It may be mentioned that the Indian Trust Act, 1882 was enacted to govern the

private trusts and charitable institutions. 36

Internationally, mutual fund can be set up either as companies or as trusts. In the

company form, the investor became the shareholders; in the trust form, the investor

became the beneficial owner of the trust.

42

Corporation (LIC) established its MF in June 1989 while General

Insurance Corporation (GIC) had set up its MF in December 1990

(Indian Institute of Banking & Finance, 2004). At the end of year 1993,

there were nine MFs, all in the public sectors with AUM of Rs. 47, 004

crores37

.

A new era in the MF industry began with the permission granted

for the entry of private sector funds in 199338

. Foreign asset

management companies were allowed to enter the MF business. In the

same year SEBI (Mutual Fund) Regulations also came into effect, under

which all MFs, 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. In 1996, the

SEBI (Mutual Fund) Regulation was substituted by a more

comprehensive and revised Mutual Fund Regulation. The industry now

functions under the SEBI (Mutual Fund) Regulation 1996. The number

of MF houses kept on increasing as more and more foreign MFs started

setting up funds in India. At the end of January 2003, there were 33

37



38



43

mutual funds with total assets of Rs. 1, 21,805 crores39

. The Unit Trust

of India with Rs.44, 541 crores of AUM was way ahead of other MFs.

However by the late 90s, US-64 (the flagship scheme of UTI mutual

fund) emerged as an example of portfolio mismanagement. In the year

1998 the reserve of US-64 turned negative and US-64 scheme started

facing redemption pressure with a wide spread panic across the country.

This scam was due to the manipulation of the capital markets to benefit

market operator, brokers, corporate entities and their promoters and

management. Following the heavy redemption wave, it soon became

public knowledge that the erosion of US-64‟s reserve was gradual. The

report of the Joint Parliamentary Committee pertaining to UTI Scam

suggested that the „persistence and pervasive‟ failure of the key

regulators to perform their duties and the failure of „good governance‟

was the key factor behind the scam40

.

The UTI Scam resulted in the repeal of the Unit Trust of India

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

Specified Undertaking of the Unit Trust of India with assets under

management of Rs.29, 835 crores as at the end of January 2003,

39



40

Aiyar, Mani Shankar (2003). Stock Market Scam and UTI Imbrogolio: JPC Report

X-Rayed. Economic and Political Weekly, 38(10), 969-980.

44

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 was the UTI Mutual Fund,

sponsored by State Bank of India, Punjab National Bank, Bank of

Baroda and Life Insurance Company. It is registered with SEBI and

functions under the Mutual Fund Regulations. With the bifurcation of

the erstwhile UTI, the MF industry in its true spirit rooted in a free

market and has entered its current phase of consolidation and growth. As

on September 2010, Indian MF industry consists of 41 AMCs that have

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

shift in the favor of private sector players as the number of public sector

players reduced from 11 in 2001 to 5 in 200941

. The list of AMC as on

September, 2010 along with their average AUM for the month of

September, 2010 is shown in table 2.1. As table 2.1 suggests Reliance

Capital Asset Management Company with average AUM of Rs. 107,749

Crore is the largest AMC in India in terms of AUM.

41

KPMG (June 2009) Indian Mutual Fund Industry-The Future in a Dynamic

Environment. Retrieved December 10, 2009 from http://www.in.kpmg.com

45

Table 2.1

Average Asset under Management of AMC in India (for the month

of September, 2010)

(Rs. in Crore)

Sr.

No.

Name of the Asset Management

Company

Average Asset Under

Management for the

month of June, 2009

A Bank Sponsored

(i) Joint Ventures- Predominantly

Indian

1 Canara Robeco Asset Management

Co. Ltd.

7,719

2 SBI Funds Management Pvt. Ltd. 42,100

Total A(i) 49,819

(ii) Joint Ventures- predominantly

Foreign

1 Baroda Pioneer Asset Management

Company Ltd.

3,731

Total A (ii) 3,731

(iii) Others

1 IDBI Asset Management Ltd. 2,200

46

2 UTI Asset Management Company

Ltd.

67,618

Total A(iii) 69,818

Total A (i+ii+iii) 123,368

B Institutions

1 LIC MF Asset Management Co. Ltd. 19,727

Total B 19,727

C Private Sector

(i) Indian

1 Axis Asset Management Company

Ltd.

4,636

2 Benchmark Asset management

Company Pvt. Ltd.

2,505

3 Deutsche Asset Management (India)

Pvt. Ltd.

6,461

4 Edelweiss Asset Management Ltd. 215

5 Escorts Asset Management Ltd. 198

6 IDFC Asset Management Company

Pvt. Ltd.

18,398

7 J.M. Financial Asset Management

Pvt. Ltd.

6,524

47

8 Kotak Mahindra Asset Management

Co. Ltd.

28,430

9 L&T Investment Management Ltd. 3,543

10 Motilal Oswal Asset Management

Co. Ltd.

305

11 Peerless funds management company

ltd.

2,622

12 Quantum Asset Management Co. Pvt.

Ltd.

119

13 Reliance Capital Asset Management

Ltd.

107,749

14 Religare Asset Management

Company Pvt. Ltd.

10,780

15 Sahara Asset management Co. Pvt.

Ltd.

756

16 Tata Asset Management Ltd. 21,964

17 Taurus Asset Management Co. Ltd. 2,694

Total C (i) 217,899

Ii Foreign

1 AIG Global Asset management

Company ( India) Pvt. Ltd.

1,020

48

2 FIL Fund Management Pvt. Ltd. 8,545

3 Fortis Investment Management

(India) Private Ltd.

4,965

4 Franklin Templeton Asset

Management ( India) Pvt. Ltd.

42,142

5 Mirae Asset Global Investments (

India) Pvt. Ltd.

275

6 Pramerica Asset Managers Pvt. Ltd. 630

Total C (ii) 57,577

(iii) Joint Ventures- Predominantly

Indian

1 Birla Sun Life Asset Management

Co. Ltd.

67,421

2 DSP BlackRock Investment

Managers Ltd.

26,674

3 HDFC Asset Management Company

Ltd.

93,106

4 ICICI Prudential Asset Management

Co. Ltd.

69,728

5 Sundaram BNP Paribas Asset

Management Company Ltd.

14,241

49

Total C (iii) 271,170

(iv) Joint Ventures- Predominantly

Foreign

1 Bharti AXA Investment Managers

Pvt. Ltd.

511

2 HSBC Asset Management India Pvt.

Ltd.

4,810

3 ING Investment Management (India)

Private Ltd.

1,468

4 JP Morgan Asset Management (

India) Pvt. Ltd.

8,448

5 Morgan Stanley Investment

Management private Ltd.

2,351

6 Principal PNB Asset Management

Co. Pvt. Ltd.

5,642

7 Shinsei Asset Management (India)

Pvt. Ltd.

319

Total C(iv) 23,549

Total C (i+ii+iii+iv) 570,195

Total A+ B+ C 713,290

Source: AMFI Updates, July-September, 2010, Vol. X, Issue I

50

Asset under management of the Indian MF industry has grown

manifolds as shown in the chart 2.1. The AUM of MF industry has

grown from Rs. 25 Crores in March 1965 to Rs. 5, 05,152 Crores in

March 2008. The year (2008-09) was of course, exceptional as the total

AUM declined presumably completely due to global financial crisis and

resulting panic across financial markets. Except for a decline due to a

financial crisis at the public sector monopoly fund UTI in the year 2003,

and global financial crisis in the year 2008-09, the industry has been

growing consistently and extremely rapidly over the years with the

“take-off‟ having occurred in the last decade or so.

Chart 2.1

Growth in Asset under Management in India (March 1965 to March

2009)

Source: AMFI Data

51

The AUM on the basis of type and category wise of MF schemes

as on September 30th

2010 is shown in Table 2.2. Table 2.2 suggests that

income fund is most favored category of asset comprises 49 % of total

AUM, followed by equity fund. Liquid and money market fund

constitute 14 % of total AUM. Further, majority of AUM is of open-

ended type comprising of 85.4 % of the total AUM.

Table 2.2

Asset under management of MFs in India (As of 30th

September,

2010)

Type and category wise

(Rs. in Crore)

Open-

ended

Close-

ended

Interval

fund

Total % of

total

INCOME 245,955 52,041 24,629 322,625 49

EQUITY 171,050 14,363 71 185,484 28

BALANCED 18,156 1,252 - 19,408 3

LIQUID/MONEY

MARKET

91,516 - - 91,516 14

GILT 3,860 - - 3,860 1

52

ELSS-EQUITY 24,063 3,411 - 27,474 4

GOLD ETF 2,849 - - 2,849 1

OTHER ETFs 1,610 - - 1,610 @

FUND OF FUND

INVESTING

OVERSEAS

2,487 - - 2,487 @

TOTAL 561,546 71,067 24,700 657,313 100

% OF TOTAL 85.4 10.8 3.76 100

Notes:

@ Less than 1 %

Source: AMFI Updates, July-September, 2010, Vol. X, Issue II

The numbers of MF schemes offered to the investors in India

also grew by 13.2 % between years 2000 to 200742

. As on September

2010 there were 918 MF schemes available in the market to cater to the

needs such as financial position, risk tolerance, and return expectation

etc of the investors. The detail of the total number of schemes in each

category is shown in table 2.3. As the table suggests that as of

September, 2010, majority (74.6%) MF schemes in India are open-ended

42

ICI Fact Book, 2008. Retrieved February 12, 2009 from http://www.icifactbook.org

53

type, followed by closed-ended schemes. The details of the total number

of schemes in each category are shown in table 2.3.

Table 2.3

Type and category wise number of MF schemes in India (As of

September, 2010)

Open-

ended

Closed-

ended

Interval Total

Equity 289 27 1 317

Income 201 154 36 391

Balanced 31 3 Nil 34

Liquid/Money

market

53 Nil Nil 53

Gilt 36 Nil Nil 36

ELSS-Equity 36 12 Nil 48

Gold ETF 9 Nil Nil 9

Others ETF 15 Nil Nil 15

Fund of Fund

Investing

Overseas

15 Nil Nil 15

Total 685 196 37 918

Source: AMFI Updates, April-June, 2009, Vol. IX, Issue 1

54

The above discussion suggests that the reforms in the financial

market in India have provided positive impetus to the growth of MF

industry in India. The reforms in various constituents of financial market

coupled with the advancement in information technology have opened

new vistas for MF industry. Today MFs are offering wide range of

products and services to the investor in India. The growth in industry in

India is also due to increased income of the average household in the

country and performance of the equity market. MF industry in India has

started showing maturity and is likely to show positive growth in the

near future. Next section discusses regulatory framework for MF

industry in India.

2.2.4.2 Regulatory framework for MF industry in India

For successful operation and development, MF industry requires

a robust and effective regulatory framework43

. As in all cases of agency

contracts, MF investors also need to be protected from fraudulent

behaviour on the part of the fund managers so that they abide by the

objectives of the MF schemes as outlined in the prospectus. The

regulatory framework for the MF industry encompasses legal character

43

Beneficial regulation has been attributed as a key factor behind the strong growth of

the US mutual fund industry (Reid, 2000)

55

and structure of MF companies, accounting and auditing rules, MF

operations, and information disclosure and transparency requirements.

Each of the above aspect of the regulatory framework is discussed in

brief in the context of Indian MF industries in subsequent paragraphs.

2.2.4.2.1 Legal character and structure of MF companies

According to SEBI (Mutual Fund) Regulation 1966, MF in India

are organized in the form of a trust by a sponsor to raise money by the

trustees, through the sale of units to the public under one of more

schemes for investing in securities in accordance with the regulation.

The above definition of MF determines its basic legal character. First, it

allows the MFs to raise resources through sale of units to the public.

Second, it permits the MFs to invest only in securities prescribed by

SEBI (Mutual Fund) Regulations. Third, it requires the MFs to be set up

in the form of Trust under Indian Trust Act, 1882.

The SEBI (Mutual Fund) Regulation 1966 and subsequent

regulations i.e. SEBI (Mutual Fund) Regulation 1993 and SEBI (Mutual

Fund) Regulation 1996 have defined the structure of a mutual fund and

segregated the various constituents into separate legal entities. The

overall structure of MF in India is shown in figure 2.2. The MFs are set

56

up as trusts and are to be managed by a separate Asset Management

Company44

(AMC). The custody of the asset is to be with a custodian,

which is independent of the sponsors and the AMCs. Arms-length

relationships have been sought to be built into the various constituents of

a MF, primarily through separation of the entities, and through the

requirement that two third of the trustees and fifty percent of the board

of directors of the AMC must be independent and not associated or

affiliated to the sponsors. Various documents viz. trust deed, investment

management agreement, which is to be executed, delineates the

responsibilities of the AMCs and the trustees.

Figure 2.2

Overall Structure of mutual fund in India

Source: http://www.amfiindia.com

44

“Asset Management Company" means a company formed and registered under the

Companies Act, 1956 (1 of 1956) and approved as such by the Board under sub-

regulation (2) of SEBI (MF) regulation 21.

57

2.2.4.2.2 Accounting and auditing rules

Accounting rules of the regulation primarily provide guidelines

for the treatment of unrealized gains/ loss, dividend income, interest

income, holding cost investment including gain and loss on sale of

investment, purchase and sale of investment with respect to open-ended

scheme and close-ended scheme, treatment of bonus shares, treatment of

expenses. Further for the purposes of preparing the financial statements,

MFs are required to mark all investments to market and carry

investments in the balance sheet at market value. However, since the

unrealized gain arising out of appreciation on investments cannot be

distributed, provision has to be made for exclusion of this item when

arriving at distributable income.

SEBI has been vested with the power to appoint an auditor to

inspect or investigate, as the case may be, into the books of accounts or

the affairs of the mutual fund, trustee or AMC to ensure that the books

of accounts are being maintained by the mutual fund, the trustees and

asset management company in the manner specified in these regulations

and to ascertain that the provisions of the Act and these regulations are

being complied with by the mutual fund, the trustees and asset

management company.

58

2.2.4.2.3 MF operations

SEBI ( Mutual Fund) Regulations, 1996 delineates the

guidelines for the operations of MFs. Specific provisions has been made

in the regulation related to the business of MFs, investment restrictions,

borrowing and valuation policies, daily pricing, risk management by

MFs , disclosure requirements, advertisements and reporting

requirements. This section briefly discuss the provisions related to

business of MFs, investment, borrowing and valuation policies, daily

pricing, and risk management. In the subsequent section provisions

related to disclosure requirements, advertisements and reporting

requirements are critically reviewed.

(a) Business of MFs

According to the regulations, AMC are not allowed to undertake

any business activity other than management of MFs in order to avoid

the „conflict of interest‟ problem. Hence AMC has to take the prior

approval from their trustees and SEBI in order to undertake such

activities like financial service consultancy, exchange of research and

analysis on commercial basis.

(b) Investment, borrowings and valuation

59

Prudential norms are prescribed in the regulation to ensure that

the investment portfolio of MFs is diversified in order to reduce the

inherent risk associated with such investments. The moneys collected

under any scheme of a MF shall be invested only in transferable

securities in the money market or in the capital market or in privately

placed debentures or securitized debts and are subject to the investment

restriction specified in the seventh schedule of the regulation.

MFs are allowed to borrow only to meet the short term liquidity

requirements for the purpose of the repurchase, redemption of units or

payments of interest or dividends to the unit holders of MF schemes.

Mutual fund shall not borrow more than 20% of the net asset of the

scheme and the duration of such a borrowing shall not exceed a period

of six months. Trustees are required to ensure that borrowing is used as a

measure of last resort. Further, MFs have to disclose this in the offer

document of the MF schemes.

Every mutual fund shall compute and carry out valuation of its

investments in its portfolio and publish the same in accordance with the

valuation norms specified in eighth schedule of the regulation. The Net

Asset Value of the scheme shall be calculated and published at least in

two daily newspapers at intervals of not exceeding one week. The price,

60

at which the units may be subscribed or sold and the price, at which such

units may at any time be repurchased by the mutual fund, shall be made

available to the investors.

(c) Daily pricing

Regulation guidelines also prescribes the accounting and

valuation norms, which guides the price determination of the units of

MF schemes. MFs are also required to adhere to the daily pricing

mechanism as prescribed by the regulation. They are required to update

the NAV of the schemes and the sale /repurchase prices of their schemes

on the AMFI website45

on the daily basis in case of open ended MF

schemes.

(d) Risk Management System

Recognizing the need to establish a minimum level of risk

management system confirming to international standards, in the year

2001, AMFI formed a committee for studying the system of risk

management and proposing ways and means of strengthening the same.

Based on the recommendation of the committee, SEBI adopted the

regulatory framework for risk management for MFs operating in India.

This was to ensure a minimum standard of due diligence or risk

45


61

management system for all the MFs in various areas of their operations

like fund management, operations, customer service, marketing and

distribution, disaster recovery and business contingency, etc. Further, the

implementation of Prevention of Money Laundering (PMLA) Rules

issued in December 2008 is a part of the risk management practices in

MF industry. Finally, Anti Money Laundering (AML) and Combating

Financing of Terrorism (CFT) measures cover two main aspects of

Know Your Customer (KYC) norms and „suspicious‟ transactions

monitoring and reporting.

2.2.4.2.4 Disclosure, advertisements and reporting requirements

MFs are required to provide full and complete disclosures about

the particular of MF scheme in a written offer document. This offer

document describes, among other things scheme‟s investment

objective(s), its investment policies, its investment methods, information

about risk exposure of the portfolio of the MF scheme and information

about how to purchase and redeem units of that MF scheme. MFs are

also required to place the fee table at the beginning of any offer

document. All MFs are required to provide their unit holders with annual

and semi-annual reports that contain recent information about the fund‟s

portfolio, performance and investment goals and policies.

62

MFs are required to adhere to specific rules regarding the sales,

distribution and advertising of MFs. Advertisement or sales literature

must be carefully worded and explained to enable investor to make

informed decisions. The advertisements are required to be in

conformance to the advertisement code as prescribed by the regulations.

MFs have to appoint a compliance officer whose role is to collect

relevant information from the various departments/ officers of the trusts,

compiles the same into standard format as prescribed by SEBI and

submits it to SEBI. This helps SEBI to do continuous offsite inspection.

The regulatory framework for Indian MF industry is believed to

match up to the most developed market globally46

. The regulator, SEBI

has consistently introduced several regulatory measures and

amendments aimed at protecting the interest of the small investors that

augurs well for the long term growth of the industry in the dynamic

environment.

2.3 Future Outlook of Mutual Fund Industry

46

KPMG (June 2009) Indian Mutual Fund Industry-The Future in a Dynamic

Environment. Retrieved December 10, 2009 from http://www.in.kpmg.com

63

In this section we initiate our discussion on the future outlook of

MF industry in the world. Next, the future outlook of MF industry in

India is discussed.

2.3.1 Future Outlook of MF Industry in the World

MFs are gaining importance worldwide due to the spectacular

growth of MF industry in the world. The industry has approximately

tripled its size from $9.6 trillion in 1998 to 26 trillion in 2007,

corresponding to an annual growth rate of 12.38 %47

. In spite of the

healthy growth of MF industry in the world there is a significant

difference in the size and structure of mutual fund industry across

nations. According to the net asset of MF, 85.6 % of the industry is

concentrated in America and Europe, and remaining in Asia Pacific and

Africa48

. The United States alone locate 45.88 % of industry, suggesting

disparity in the growth of MF industry in the world. Mutual fund

industry is larger in developed countries and the countries with a strong

institutional environment (Ramos, 2009). The industry is smaller in

countries where entry barriers are higher (Ramos, 2009). Other factors

47

2008 ICI Fact Book. Retrieved February 12, 2009 from http://www.icifactbook.org 48

2008 ICI Fact Book. Retrieved February 12, 2009 from http://www.icifactbook.org

64

that have influenced the size and structure of mutual fund industry is

percentage of educated population, level of the maturity of industry

(age), presence of multinational financial institution in the country,

performance of equity and bond market, tax incentive and regulatory

framework, attractiveness of complimentary and substitute financial

products and operational efficiency of mutual fund industry (Fernando et

al. 2003; Khorana et al. 2005; Ramos, 2009).

2.3.1.1 Size of MF Industry Worldwide

Traditionally, size of the mutual fund industry has been

measured by total net assets (Ramos, 2009). As shown in table 2.4, the

countries which have shown impressive growth in the mutual fund

industry between year 2000 and 2007 are Romania 74.33 %, Russia

69.79 %, Poland 62.22 %, and Philippines 52.76 %. India has also

shown an impressive growth of 34.72 % along with Ireland 31.93 %,

Hungry 30.52% and Finland 30.37 %. The countries which have shown

negative growth in mutual fund industry during the above period are

Italy and Argentina. United States have shown a steady growth rate of

8.12%, Japan 7.45 % and Luxembourg 20.07 %. The growth rate has

varied across regions also. America has grown at 8.86 %, Europe at

15.42 %, Asia Pacific at 18.33 % and Africa at 28.02 % indicating the

increasing level of attractiveness of mutual fund products in Asia Pacific

65

and African region in the last decade or so. Apart from the other factor

the different rate of growth in various regions is due the stage at which

mutual fund industry exist in that region and the base size. MF industry

in U.S. is most developed whereas in China it is at earlier stage (Ramos,

2009). In terms of total net asset, as on the year end 2009, 48.42 % of

the asset are located in United States, 9.99 % assets in Luxembourg due

to its large role as an offshore centre and 7.86 % assets are located in

France.. India holds only 0.567 % of the total asset of the world. In

future there is lot of growth prospect of MF industry in China, India,

Russia and Turkey. However, this will require a collaborative effort

across all stakeholders and enabling support from the regulators.

Table 2.4

66

Size and growth of MF industry in the world (Total net assets and

number of MF schemes)

Total net

assets (US $,

end of the

year 2009)

Growth rate

(%) (2000-

2007)

Number of

MF

Schemes (

End of the

year 2009)

Growth

(%)

(2000-

2007)

World 22,964,267 11.99 65,735 3.64

Americas 12,597,242 8.86 16,982 2.88

Argentina 4470 -1.27 252 0.92

Brazil 783,970 22.54 4,744 7.07

Canada 565,156 13.99 2,075 3.27

Chile 34,227 26.99 1,691 36.37

Costa Rica 1,309 3.93 64 -3.81

Mexico 81,552 22.27 429 4.68

Trinidad and

Tobago

5,832 NA 36 NA

United States 11,120,726 8.12 7,691 -0.22

Europe 7,545,531 15.42 33,054 4.72

Austria 99,628 13.69 1,016 5.01

67

Belgium 106,721 11.43 N/A 8.79

Bulgaria 256 NA 85 NA

Czech

Republic

5,436 21.11 78 -0.84

Denmark 83,024 18.30 483 3.47

Finland 66,131 30.37 377 6.69

France 1,805,641 15.60 7,982 2.07

Germany 317,543 6.60 2,067 5.78

Greece 12,434 0.32 210 -2.01

Hungary 11,052 30.52 264 13.77

Ireland 860,515 31.93 2,721 11.61

Italy 279,474 -0.15 675 -0.65

Liechtenstein 30,329 N/A 348 N/A

Luxembourg 2,293,973 20.07 9,017 5.39

Netherlands 95,512 2.85 N/A -0.71

Norway 71,170 24.40 487 4.33

Poland 23,025 62.22 208 13.62

Portugal 15,808 8.70 171 -1.14

Romania 1,134 74.33 51 14.40

Russia 3,182 69.79 480 46.44

Slovakia 4,222 N/A 54 N/A

68

Slovenia 2,610 N/A 125 N/A

Spain 269,611 12.65 2,588 2.81

Sweden 170,276 13.98 506 -0.92

Switzerland 168,260 11.36 509 6.38

Turkey 19,426 N/A 286 N/A

United

Kingdom

729,141 14.74 2,266 2.21

Asia and

Pacific

2,715,233 18.33 14,795 1.74

Australia 1,198,838 19.56 N/A N/A

China 381,207 N/A 547 N/A

Hong Kong N/A 22.68 N/A 2.53

India 130,284 34.72 590 13.15

Japan 660,666 7.45 3,656 1.01

Korea, Rep.

of

264,573 16.92 8,703 0.62

New Zealand 17,657 9.72 702 0.37

Pakistan 2,224 N/A 96 N/A

Philippines 1,488 52.76 41 12.10

Taiwan 58,297 8.93 460 6.79

Africa 106,261 28.02 904 13.92

69

South Africa 106,261 28.02 904 13.92

Source: ICI Fact Book, 2008, ICI Fact Book, 2010

2.3.1.2 Structure of MF Industry

Mutual Fund can be categorized according to the asset class.

Categories include bond, equity, mixed assets, money market and other

mutual funds. The distribution of assets also varies across regions and

countries. In United States, 40 % of the total mutual fund assets consist

of domestic stock funds; if international equity fund is also included it

becomes 54 % of the total assets, followed by money market funds with

26 % of the total assets (ICI fact book, 2008). In Europe, UK, France

and Germany together account for more than 50 % of the AUM49

. ,

Further out of the total AUM at the end of year 2007, 40 % of AUM

consists of bonds, 7% equity and 13 % money market mutual funds50

. In

UK, 52 % of the asset consists of equity funds, followed by 32 % in

fixed income and 9 % in money market mutual funds51

. In France, 42 %

of asset consist of bond, 25 % equity and 23 % money market mutual

49

EFAMA (April 2009). Asset management in Europe: facts and figure. Retrieved

October 4 , 2009 from http://www.afg.asso.fr 50




October 4 , 2009 from http://www.afg.asso.fr

70

funds52

. In Germany, 51 % of asset consist of bond, 24 % equity and 6

% money market mutual funds53

. In Asia Pacific region, Japan and

Australia dominates the market in terms of asset under management54

. In

Asia 62 % of assets are invested in equity, 19 % in bonds and 9 % in

money markets55

. Among the countries in Asia Pacific, Taiwan and

Thailand investors prefer bond mutual funds. In Taiwan, 59.81 % of the

total asset consists of bond followed by 27.61 % of total asset as equity.

In India, income fund is the most preferred category of asset comprising

of 49 % of the total asset. Money market fund comprises of 19 % of the

assets56

. Equity fund is the most preferred asset class in China

comprising of 42.5 % of the total assets. Money market MF consists of

9.3 % of total AUM57

.

Worldwide there are approximately 66,000 MFs schemes

primarily comprising of bond, equity, mixed assets, and money market

52





KPMG (2008). State of investment management industry in Asia Pacific. Retrieved

October 5, 2009 from http://www.in.kpmg.com 55

KPMG (2008). State of investment management industry in Asia Pacific. Retrieved

October 5, 2009 from http://www.in.kpmg.com 56

AMFI Update, April-June, 2009, Vol. IX, Issue 1. Retrieved December 10, 2009

from http://www.amfiindia.com 57

KPMG (2007). “China‟s fund management joint ventures; The growing flow of

wealth”. Retrieved October 7, 2009 from http://www.in.kpmg.com

71

mutual funds58

. Apart from the above, the major innovation in MF has

been to extend the product to include portfolios in other asset classes

like gold, real estate etc., international equities and debt, fund of fund,

and sector specific funds. Moreover, there is now a language to describe

the “style” of MF portfolio. MFs are commonly categorized by the

capitalization (small, mid cap, large) and the growth orientation (growth,

value, and blend) of their holdings.

2.3.1.3 Mutual Fund Expense/ Charges

MF companies charge fees from investors in order to compensate

for the management costs of the fund (annual charges). In addition, MFs

often charge a sales surcharge when the investor purchase (initial

charges) or sell shares (redemption charges). There are differences in the

way MF charge investor fees. Previous studies suggest that the MF

expense/ charges worldwide is a function of industry size, stage of

development of the industry, cost of distribution, nature of funds,

judicial activism and media activism (Ramos, 2009). Larger industries

tend to have lower annual charges consistent with evidence on MF

economies of scale (Baumol et al., 1990; Barber et al., 2005). Further,

industries in the earlier stage of development have „fewer entry barriers‟

to encourage investors, as investors are more sensitive to front end loads

58

ICI Fact Book 2010. Retrieved August 10, 2011 from http://www.icifactbook.org

72

than to operating expenses (Barber et al., 2005). In another study Ramos

(2009) analyzed MF industry in 20 countries using a sample of more

than 50,000 MF schemes and suggested that overall, the annual average

charge in Europe and Asian countries is twice that of the U.S. Further,

the study analysis on the sample of MF schemes revealed that the annual

charge by MF industry was maximum in Poland (1.77 %) and minimum

in U.S (.54%). Further, the initial charges by MF industry were

maximum in U.S (3.91%) and minimum in Spain (.01%). Redemption

charges were found to be maximum in U.S and there were no

redemption charges in Taiwan, Poland, Korea, Italy, and Germany. The

total charges were found to be maximum in Poland (1.95%) and

minimum in Korea (0.86%). For India, the total annual charges were

found to be 1.09 % for the sample of companies selected for the

analysis.

In future also, it is likely that MF industry in most of the

countries will feel the pressure on the fee front, however, the effect is

likely to be small (Khorana and Servaes, 2008). Only those fund

families will succeed which can successfully differentiate their product

offerings so that investors focus on elements besides fees and

performance.

73

2.3.1.4 Geographical Focus

Geographical focus of the fund may be a country, a region or

even the world like global funds. MFs in Asian countries have a high

level of home bias (Ramos, 2009), the exception are economically open

countries such a Singapore and Japan. Funds in China focus exclusively

on their home country. In India, recently MFs have started focusing

outside India, in spite of that there is a high level of home bias. MF

industries in Austria, Belgium, Finland, France, Germany, Italy and

Singapore invest only a small fraction of their assets in the home

country. European funds show low level of home bias this may be due

to the common currency in the Europe. U.S MF also primarily invests in

U.S and North America (Ramos, 2009). In future it is likely that funds in

more and more country will start focusing outside their country in search

of efficiency and performance. This effort will be augmented by the

opening up of more and more economies, emergence of new economies

globally like China, India, Brazil Russia etc., and reduced attractiveness

of the existing giant economies like U.S and Japan.

Apart from the above in future, it is likely that MF industry will

see consolidation in the industry among smaller companies and cross

border merger among financial institutions in most part of North

74

America and Western Europe. This is due to the fact that currently in

developed markets, even though the industry is quite mature and funds

are being offered by large number of organizations, yet a large fraction

of market is captured by few large companies (Khorana and Servaes,

2008). Another factor that is likely to see an improvement in the future

is the fund governance in maturing countries like India. Last but not the

least, the investors‟ level of financial literacy and awareness with MF is

crucial for the future health of the MF industry in the world.

2.3.2 Future Outlook of MF Industry in India

Indian MF industry is marked with low penetration levels

combined with rapid growth in the AUM in recent years point to the

high growth potential of Indian MF industry. This significant growth in

the MF industry has been witnessed due to numerous reasons like

favorable economic and demographic factors such as rising income level

and increasing reach of AMCs and distributors. However, after several

years of relentless growth, the industry witnessed a fall of 8% in the

AUM in the financial year 2008-09. Recent development triggered by

the global financial crisis have served to highlight the vulnerability of

the Indian MF industry to global economic turbulence and exposed our

increased dependence on corporate customers and the retail distribution

75

system59

. Hence, the future health of the MF industry in India is likely to

depend on several factors. Some of the forces that will shape the future

of MF industry in India are as follows; first, overall economic

development of the country measured through growth in the GDP;

second, change in the demographics of individuals; third, structure of

current and future social security system; fourth, technological

innovations; and fifth, enabling support from the regulator and

government agencies.

.

2.3.2.1 Overall Economic Development

The economy of India is the twelfth largest economy in the

world by market exchange rates and fourth largest by purchasing power

parity (PPP) basis60

. In the year 2009, there has been a significant

slowdown in the growth rate to 6.1 %.61

. India is projected to grow at

about 8% till 202062

. However, this requires a quick economic revival

in the overall economy of the country. In the above circumstances, MF

industry in India is likely to grow at the rate of 22-25 percent in the

59

KPMG (June 2009). Indian Mutual Fund Industry-The Future in a Dynamic

Environment. Retrieved December 10, 2009 from http://www.in.kpmg.com 60

CIA-The World Fact Book-Rank Order-GDP Purchasing Power Parity Retrieved

December 10, 2009 from http://www.cia.gov 61

2009 MOSPI Official Press Release. Retrieved December 10, 2009 from

http://www.mospi.gov.in 62

Goldman Sachs (2007). India‟s Rising growth potential. Retrieved December 10,

2009 from http://www.portal.gs.com

76

period from 2010 to 2015, resulting in AUM of INR 16,000 to 18,000

billion in 201563

. Even in the event of slower economic revival, the

Indian MF industry may grow in the range of 15-18 % in the period

from 2010 to 2015, resulting in AUM of INR 15,000 to 17,000 billion in

201564

which will be much higher than the current global average of 4%.

2.3.2.2 Demographic Changes

One of the factors that is likely to influence the future of MF

industry in India is the predictable change in the demographics of the

country. In U.S. the movement of baby boomer into retirement has

already motivated innovations in MFs and is likely to spur even more

(Tkac, 2007). In India, the majority 62.7 % of the population is in the

age group of 15 to 64 years65

. Hence, for most of the Indians, this is

their prime wealth accumulation years including saving for retirements.

Hence, the current demographics in India provide opportunity to the MF

industry as more and more individuals will plan for their retirements.

This requires that MF industry aggressively focus on retail investor

participation by moving beyond Tier 1 towns and innovations in

63





Retrieved December 10, 2009 from http://web.worldbank.org.

77

distributions as the average age of the population distribution moves

predictably, inexorably, to the right as time passes. In future, it is

expected that average percentage of population in the age group of 15 to

64 years is likely to fall down and more and more retirees will be the

part of the population. MF industry in India will have to come up with

the solutions for optimal asset accumulation and optimum asset

deaccumulation. Hence, in the future there is likely to be an increase in

demand for advice and product that help investor understand, plan and

implement their preferred investment strategy.

2.3.2.3 Structure of Current and Future Social Security System

Social security system is going to have substantial influence on

the way individual will manage their finance to take care of their

retirement needs. In India, social security system has evolved since

independence in 1947. India has now entered the fifth phase of

demographic transition characterized by declining fertility rate. India

aimed at replacement level Total Fertility Rate (TFR) by 2010, which is

likely to result in stable population level by the year 204566

. The number

of elderly (those above 60 years of age) however is expected to increase

very rapidly from 72 million (7.1 % of the total) in 2001 to 177 million

66

Retrieved December 28, 2009 from www.iief.com/Research/mukulasher1.pdf.

78

(13 % of the total) by the year 2025 (Government of India, Ministry of

Social Justice and Empowerment, 2000). Along with population ageing

India is also experiencing rapid individual ageing reflected in longer life

expectancy. Till recently, Indian social security system has following

four characteristics67

. First, Indian security system was overwhelmingly

welfare oriented. Second, the welfare orientation and relative neglect of

administrative and civil service reform meant that more emphasis needs

to be given to efficiency and minimization of transaction cost. Third,

there has been a marked dualism in the provision of social security

benefits. This dualism is most evident in the relatively secure and

generous retirement benefit of the civil servants without any

contribution by them to the defined benefit pension scheme on the one

hand, a meager funds for public assistance schemes for the elderly poor

on the other. In between are the private sector employees who are

covered by the EPFO schemes. Fourth, each component of India‟s social

security system has developed separately, without any agency

responsible for a system wide perspective. In the year 2003, Pension

Regulatory and Development Authority (PFRDA) were established. The

mandate of PFRDA is the development and regulation of pension sector

in India. The establishment of PFRDA has led to various reforms in the

pension sector including the roll out of New Pension Scheme (NPS) on 1

67

Retrieved December 28, 2009 from www.iief.com/Research/mukulasher1.pdf.

79

May, 2009. The future direction of pension reforms in India suggests (a)

non sustainability of government sponsored pension schemes due to

sharp increase in financial burden on the government (b) movement

from a defined benefit pension to a defined contribution based pension

system (c) more and more responsibility on the individual to take care of

their post retirement needs and financial well being. This requires that

individuals acquire enough wealth, through saving and investment

decisions, during their working years to finance consumption throughout

their retirement. In the above backdrop, MF industry can effectively tap

the higher percent of the gross household financial savings by offering

attractive life cycle based investment solutions to the investors. Further,

with the rise in the disposable income and increased financial savings,

MF industry can expect increased retail investor participation. A right

combination of top performance, extensive research on retail investor

(Bhave, 2008), making itself investor centric (Sinha, 2009) by investing

in investor education will open up new frontier for MF industry in the

future.

2.3.2.4 Technological Innovations

The future of MF industry will also depend on the ability of the

MF industry to provide investment solutions at affordable price.

80

Technology will play vital role in this regard. Those countries where

transition in MF industry is from a maturing industry to matured

industry ( including India), there is a need to emphasize on adopting the

global best practices such as outsourcing accounting and compliance,

provision of cost effective information and investment advice, building

collaboration with banking and telecommunication industries and

introduction of host of technological innovations68

. This is necessary for

the MFs to make successful progression from being an investment

vehicle to investment solution. In the future it is likely that technological

advances will decrease the cost of computation and computer memory

by making it possible to disseminate information and accounting

services over internet.

2.3.2.5 Support from Regulators and Government Agencies

Regulatory framework of MF industry in India is believed to

match up to the most developed market globally. The regulator, SEBI

has consistently introduced several regulatory measures and

amendments aimed at protecting the interest of the small investors that

augment well for the long term growth of the industry. The regulatory

68

CII-PWC (2008). Indian Mutual Fund Industry: Sustaining growth in a maturing

market. Retrieved December 10, 2009 from http://www.webnewswire.com

81

and compliance ambit seeks to dwell on a range of issues including the

financial capability of the players to ensure resilience and sustainability

through increase in minimum net worth and capital adequacy, investor

protection and education through disclosure norms for more information

to investors, distribution related regulations aimed at introducing more

transparency in the distribution system by reducing the information gap

between investor and distributors, and by improving the mechanism for

distributors remuneration.

The success of the relatively nascent MF industry in India, in its

march forward, will be contingent on further evolving of a robust

regulatory and compliance framework, reduction of regulatory overlaps,

and level playing field in comparison with other verticals within

financial services sector.

Apart from the above, other key performance area which is likely

to sustain the growth of MF industry in India is the increased penetration

of MF products by bridging the rural-urban divide, marketing of MF

products by developing new and effective delivery channels by

leveraging on technology, increasing the understanding and awareness

of MF products and understanding the investment behaviour of MF

investors (Bhave, 2008).

82

2.4 Chapter Summary

During the last decade, the net assets of mutual fund industry

have witnessed the tremendous growth all over the world. However, in

spite of this healthy growth a significant difference exists in the size and

structure of mutual fund industry across the nations. The United States

alone captures about half of the world mutual fund industry, suggesting

disparity in the growth of world MF industry. Mutual fund industry has

grown larger in those countries which are developed and have a strong

institutional base whereas the growth of mutual fund industry has been

smaller in those countries which have high entry barriers. Other factors

that have influenced the size and structure of mutual fund industry are

percentage of educated population, level of the maturity of industry

(age), presence of multinational financial institution in the country,

performance of equity and bond market, tax incentive and regulatory

framework, attractiveness of complimentary and substitute financial

products and operational efficiency of mutual fund industry .

Indian MF industry witnessed an impressive growth till the year

2007 and gave an impression of becoming a mature industry. However,

after several year of relentless growth the industry witnessed a fall in the

net assets in the year 2008 and subsequently in the year 2010, suggesting

83

its vulnerability to local financial market and global economic crisis.

Apart from the global economic environment, the future health of the

MF industry in India is also likely to depend on several factors. Some of

them are as follows; first, overall economic development of the country

measured through growth in the GDP; second, change in the

demographics of individuals; third, structure of current and future social

security system; fourth, technological innovations; fifth, enabling

support from the regulator and government agencies; sixth, bridging

rural urban divide; seventh, comprehensive investor awareness program;

and eight, understanding the behaviour of MF investors particularly

retail investors.

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