Have mutual funds been a success?

Twenty years on have they been a success? The answer depends on who you are asking.

Two decades after the Indian mutual fund industry began, the obvious question to ask is... well, that’s the problem, actually. What is the obvious question to ask? 

In general terms, I guess one should ask whether (or to what extent) mutual funds have achieved their goal. However, there can be no consensus on what that goal was. Along the way, Indian mutual funds have collected a variety of goals, some stated explicitly and others implicit. 

Depending on what’s important to you and who you are, you might decide whether the funds have succeeded or failed. 

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One can look at the impact of Indian mutual funds on two separate groups of people — those who have invested in them, and those who could have invested in them but didn’t or couldn’t. And then there’s the impact on the economy at large.

An important part of the reason is the question of why we consider 2013 the 20th anniversary of the Indian mutual funds business even though the Unit Trust of India – UTI Mutual Fund’s ancestor – was founded in 1964 and during the eighties, a whole host of public sector banks and insurance companies launched mutual funds. 

The reason is that these outfits launched products that they called mutual funds, but they weren’t actually funds. 

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For the most part, their so-called funds were deposit-like products, which had a fixed tenure and were seen by consumers as just another product – or scheme, which was the chosen word – from a government organisation.

In the mindset that savers had in the eighties, there was little difference between a post office deposit and a mutual fund launched by, say, Canara Bank.

Eventually, this confusion came back to bite some of this issuers hard when it turned out that the managements of these worthy organisations were also equally confused. They had issued guaranteed-returns mutual funds, which eventually had to be paid out of the organisations’ own funds. 

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Clearly, these schemes were not mutual funds. Still, by the late eighties, some of them had launched at least some products that were like modern equity mutual funds in concept and execution.

UTI’s Mastershare and Canbank’s Canshare and Cangrowth were notable examples.

Even so, it was only when private and foreign mutual funds were allowed from 1993 that a broad-based, competitive mutual fund industry was created. The basics of customer service and transparency, like daily calculation of net asset value (NAV) were started. 

The biggest innovation was the launch of open-ended funds. Given the poor market mechanics of the time, announcing daily NAVs and redeeming investors’ funds within three days, any time they ask for it, were the kind of innovations that actually created the modern mutual fund industry. The old public sector faux-funds either died out or eventually shaped up.

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But how far did the funds succeed in building a market for investments? During these two decades, the total assets managed by the industry has grown from two per cent to eight per cent of the gross domestic product (GDP).

This certainly looks like decent growth and in a sense, it is. But there is one more number that one must look at and that’s the growth of equity assets.

The reason is that the mutual fund industry is really two separate industries: a retail-oriented equity investment management industry and a very different wholesale, corporate deposit service, that comprises the fixed-income funds.

There is some overlap but this is the basic division. Inherently, there’s nothing wrong with this - parking large amounts of corporate cash is an important service in a financial system and mutual funds do it better than banks.

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Still, on running the numbers, we find that in 1993, equity assets were 1.2 per cent of the GDP, while now they are 2.2 per cent.

This isn’t significant growth. If the original intent was that funds would allow household savings to flow into equity and the returns from well-managed equity investments to flow back to households, then we haven’t reached very far in doing this.

One, however, has to contend with the nature of the equity investments culture in India. In all these years, the Indian investor sees equity as a punting vehicle where long term means a few months or a year. The inherent variability of equity-backed investments has meant that it’s seen as a trading rather than a savings asset.

Ideally, Indian mutual funds would have had a larger corpus of equity funds with all of it coming from steady systematic investment plan investments of retail investors. 

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More, the retail investors should not just be from the big cities but smaller ones as well.

This is where the glass is half-empty, and is likely to remain so for a long time. Pick a random person who is prosperous enough to save and you’ll find that awareness and interest in mutual funds is far lower than it should be.

But this is not the “investor awareness” issue that is often talked about. For the most part, it is a symptom of the same problem that we see elsewhere - financial investments in general are on the back foot compared to real estate or gold.

We’ve settled into a mode of thinking in which financial vehicles are like deposits meant for parking money while real estate and gold are investments.

This hasn’t changed and is unlikely to change, while the fund industry has been busy earning its daily bread from easy-to-sell products and the government has focussed more on making funds safe and less on encouraging people to invest. 

If nothing much changes, then mutual funds will remain a niche product for corporations on one side and mostly high net-worth individuals on the other. In other words, for those who understand them and actively seek them out.

The writer is CEO, Value Research.