The rising clout of mutual funds

Last week, the mood was celebratory as the mutual fund industry congregated at the annual AMFI Mutual Fund Summit, in Mumbai.

And why not? The total assets managed by Indian MFs, at ₹19.5 lakh crore is at a record and has more than trebled in the last five years. Interestingly, this expansion has been driven as much by retail investors, as the conventional corporate treasuries.

As of end-March 2017, retail investors had parked a whopping ₹8.7 lakh crore with domestic mutual funds. This is up from ₹3.2 lakh crore just five years ago, a study by the industry body AMFI jointly with Crisil shows. Indian mutual funds now feature more than 5.2 crore retail investor accounts.

Clearly, MFs are breaking free from the crisis of confidence five years ago to emerge as a popular investing vehicle for retail investors. This has structural implications for the market itself.

More market clout

A few years ago, FPIs had the Indian stock market by the scruff of its neck. If FPIs brought in more money, the indices would promptly spiral upwards. If they left the party, they would swoon. But the rising clout of domestic institutions such as mutual funds has changed this.

MF equity assets have expanded from ₹2.2 lakh crore to ₹6.4 lakh crore between March 2012 and March 2017. More money under management has meant greater clout for domestic funds in the stock market. Data from the AMFI-Crisil study shows that, from owning 2.9 per cent of the outstanding shares in the market by value (full market capitalisation) just three years ago, mutual funds now own 5.5 per cent.

This number is more significant than it may seem. As promoters control 47 per cent of the outstanding shares in the Indian market, only 53 per cent are freely tradeable.

Therefore, mutual funds now own more than 10 per cent of the freely tradeable shares by value.

With insurers sitting on another 8-9 per cent, domestic institutions now carry at least half the market clout of the all-powerful FPIs (who own about 40 per cent of the free float).

This has rendered the Indian stock market more resilient to FPI pull-outs.

To cite an instance, between October 2016 and January 2017, foreign investors withdrew a net ₹39,979 crore (roughly $5.8 billion) from Indian equities. A few years ago, this would have set off a market rout.

But on this occasion, the BSE Sensex saw a barely-felt 1 per cent dip over the four-month period. This is because as FPIs sold, domestic institutions stepped in with almost matching net purchases of ₹39,823 crore.

In fact, MFs gaining muscle is a trend that isn’t restricted to the stock markets alone. With better tax treatment of returns, debt funds have been gaining ground as an alternative to bank deposits with retail investors. Mutual funds today corner 10.4 per cent of the outstanding debt issuances in India too.

Bull markets always trigger a retail rush into equity MFs. But the enthusiasm usually wanes the moment the music stops.

If stock prices pause in their rally or decline, fund flows are usually quick to dry up. This time too, retail interest in equity MFs did pick up well after the stock markets took off, in 2014.

But the interest hasn’t waned during choppy or downbeat markets. Net inflows into equity-oriented MFs have held up at more than ₹90,000 crore for each of the last three fiscal years.

This is despite the BSE Sensex charting a very different path in these three years. It delivered a bumper return of 25 per cent in FY15, slumped by 6 per cent in FY16 and notched up modest gains of 16 per cent in FY17.

It is the runaway popularity of SIPs, or systematic investment plans, that should take credit for the stability of MF flows.

Five years ago, about a fourth of total inflows into equity funds came in by way of SIPs. In FY17, SIPs brought in ₹43,921 crore, or nearly half of all inflows.

The popularity of the SIP route has wrought a sea change in retail investor behaviour, because it takes away the temptation to closely watch the markets and alter one’s investments based on its ups and downs. SIPs, by allowing investors to set up standing instructions with the bank to invest a fixed instalment each month, essentially put one’s investments on autopilot.

Today, with equity MFs raking in close to ₹4,600 crore every month via SIPs, domestic MF managers always have some powder dry to deploy in the stock market. That’s a break from the past. When lumpsum investments were in vogue, domestic fund managers would be flush with cash at market highs and staring at empty coffers after a free fall. They would, therefore, end up buying at highs and selling at lows, like novice investors.

Contrarian view

But, with SIPs smoothing out the flows, fund managers can now take a contrarian position to FPIs if they wish. If domestic fund managers use this new-found clout wisely, it may mean a higher floor to the stock market when foreign investors are in a jumpy mood.

Despite the recent surge in retail interest though, MFs are nowhere close to displacing bank deposits or the provident fund/ insurance policies as the favourite investment channel for Indian households. MFs accounted for just a 2 per cent share of gross financial savings in FY16, while bank deposits hogged 44 per cent and provident funds/insurance took up 36 per cent.

Optimists may like to look at this as a glass half full. After all, a 2 per cent share for MFs in the savings pie means that 98 per cent of that pie is still waiting to be devoured. But that expansion is contingent on two factors.

One, it is dependent on income growth and a rapid expansion of the urban elite in India. The saver’s allocation to market-linked investment vehicles depends on his ability to take risks in the market.

Deposits still mainstay

It would be unreasonable to expect savers at a subsistence level of income to allocate any part of their savings to MFs, whether debt or equity. For them, bank deposits would still constitute the mainstay.

Therefore, further asset growth for the MF industry is closely intertwined with income growth in India and the ability of more savers to climb up from the lower- and middle- income groups to the mass-affluent category.

Two, some of the new-found investor fancy for this vehicle is also due to the impressive recent records of both equity and debt funds. Retail investors, the world over, chase past returns.

In the last three years, diversified equity funds, as a category, piggybacking on a favourable market delivered an 18 per cent CAGR (data sourced from CRISIL AMFI) while liquid funds notched up 8.1 per cent. These returns are well above long-term averages.

When both equity and debt markets are coming off a particularly good spell, it is all the more challenging for fund managers to sustain those returns on a high base.

Whether fund houses manage that feat and serve up a good return experience for retail savers who are recent converts to MFs, will also decide if this party will go on.

(This article first appeared in The Hindu dated July 2, 2017)