Mutual Funds (MFs) – The Stream Swells into Mighty River

Market aficionados at the moment are quite possibly fixated on the imminent central budget, if only, to speculate the future course of capital markets. But budgets may come, budgets may go, MFs have continued their triumphant march. Every time Nifty makes a life time high, we witness some champagne popping, but hardly anybody seems to have noticed the aggregate AUM (Assets Under Management) of MFs crossing Rs 50 lac crore in December 2023, a five fold increase in 10 odd years. Of this 59 per cent, that is, nearly Rs 30 lac crores belongs to individual investors. This is almost the same as the money held by individuals directly in stocks, which Primeinfobase estimates at Rs 30.4 lac crores in September 2023. Although hardly recognized, this achievement of the MF industry as a vehicle for wealth creation by changing household saving habits is significant by any reckoning. This milestone was reached in a much shorter period since mid nineteen eighties (ignoring the lonely furrow ploughed by erstwhile UTI), while the stock exchanges have been around since 1875. Taken together, the wealth created by MFs and direct investment in stocks, has unleashed a palpable wealth effect for substantial number of Indian households. This possibly explains why even in spite of sluggish growth in their incomes, many a household is splurging on premium goods and services. In fact, the RBI data estimating household savings in stocks and mutual funds at less than 1 per cent of the GDP tends to downplay the wealth effect, because it computes these savings on the basis of inflows into these assets at cost.

Although there have been ups and downs, MFs have managed to build a long term track record on returns which has weaned the retail investors away from the guaranteed return schemes of dubious  unregulated entities such as PACL and Sahara. Large cap equity funds have delivered 11-16 per cent annualized returns over the last 20 years while debt funds have managed 7 to 9 per cent in a decade.

Even the dumbest investor can succeed in creating wealth over the long term through the MF route. The key phrase is “long term”. It doesn’t require rocket science to invest in an index fund and stay put. If one had invested Rs 1 lac in Sensex in 1980 (when the base value was 100), she would have had Rs 7.3 crores when Sensex crossed 73000 in January 2024! In other words the initial investments would have doubled every 4.25 years or so. Yet the reality is that far too many investors are not happy with their MF investments. Possibly because MF investments are chased for quick gains without any relation to the goals to be achieved over different time horizons, or return expectations have been far too unrealistic prompting investors to exit the schemes prematurely.  Equity related funds do create wealth in the long run, but in the short term they carry the risk of wealth destruction as well! Well, the question then is how long is long term? If you take 10 year rolling returns of Sensex since 1980, it will be observed that the investor has never lost his capital. But if you reduce that period to say, 5 years, there could be instances where there would be of loss of capital. So empirical evidence would suggest that long term should be at least 10 years. This point needs to be conyed to the investors ( covered by nearly 14 crore fresh MF folios) who have entered the equity arena in the frothy post-covid market. Whether these investors are aware that equities can deliver capital losses is moot. The challenge for the fund industry is to effectively convey this message and tone down exaggerated investor expectations of returns. May be additional inflows in overheated categories or those with limited liquidity and resultant high impact costs may have to be gated or brought exclusively under Systematic Investment mode. A second issue is that of too much money chasing too few stocks. While AUM of MFs has swelled manifold, the number of investment-worthy stocks has not gone much beyond 500 or so listed names. SEBI could revisit definition of market cap segments in terms of percentiles instead of by groups based on their ranking in the listed universe.

But SEBI certainly has played a role in the stellar growth of the MF industry. Although, quite frequently industry lobbies have urged SEBI to go soft on consumer protection objectives to promote ease of doing business, it is now clear that SEBI mandated hard limits on fees, banning upfront commissions, opening up direct route and ushering in, true-to label rules have anchored the long term growth of MF industry on safe and sound footing. In hindsight at least, it is easy to appreciate that that tight monitoring and regulation have ensured that the size of MF industry has grown to surpass Rs 50 lac crores without any large fraud or scam where investors have had their capital wiped out. (The last such event was the US-64 bailout). Howevr, despite SEBI writing new regulations at a brisk pace, there have been instances of mismanagement and lack of adequate governance. Thanks to quick intervention of the regulator and courts, Franklin Templeton managed to return capital to investors after the AMC abruptly barred investors from redeeming their units in six troubled schemes in 2020. Nevertheless, the shuttering of schemes subjected investors to opportunity costs and prolonged loss of liquidity. This calls for further refinement of the procedure for suo moto lock-in of investors by MFs in their schemes.

Also, how a dealer at Axis MF managed to run an elaborate scam to front run the fund’s trade without it coming to the attention of his managers, calls for more stringent risk management, governance and hiring processes. The trust of the investors that the MF industry has earned during last couple of decades can be lost overnight should there be major scam in the industry.

Eternal vigilance is the price of abiding success.