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Wednesday, Jan 28, 2004

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Tenth Anniversary Special - Mutual Funds

The fall and rise of mutual funds

Aarati Krishnan

CAN you, today, imagine investing in a mutual fund and waiting four months for it to declare its first NAV (net asset value)? Or, waiting for a fund to open its "repurchase window" to sell your investment? Would you invest in a fund that unveils its portfolio only once a year? To mutual fund investors just ten years ago, these were the norm. Nothing bizarre.

Ten years ago, close-end funds were the order of the day. Most debt funds offered assured returns. And even equity funds managed to convey the impression of fixed returns by sporting calling themselves "Triple Plus" and "Double Square Plus". Equity funds were largely judged by their dividends, rights and bonus offers, rather than by the returns.

The mutual fund industry has lived through its share of crises of confidence over the past ten years. And there are still grey areas. But the regulatory framework, disclosure norms and service standards have all changed beyond recognition, making mutual funds one of the most investor-friendly avenues available today.

Private sector plays: When the first crop of private sector-sponsored mutual funds (such as Kothari Pioneer, 20th Century Finance and Apple Finance) debuted in 1993-94, they had a difficult time weaning investors away from the Unit Trust of India and the public sector bank-sponsored funds.

The bull market of 1994 and the subsequent IPO boom changed all this. With retail investors tasting the power of the equity, a spate of private equity funds made their debut in 1994-95.

Funds such as the Apple Midas the Goldshare and Morgan Stanley Growth Fund drew retail investors in large numbers. Unfortunately, as the IPO bubble burst, and the equity market went into a slide, so did the NAV of the equity funds launched in the bull market.

But the important development during this period was the emergence of open-end funds, which offered on-tap liquidity to their investors and raised the bar on NAV and portfolio disclosures.

The second coming: After the upsets of 1994-95, it was a slow and painstaking recovery for the private sector funds. In the five years that followed, many more private sector funds threw their hat into the ring, some of them big global names such as Alliance Capital, the Templeton group, Newton and Principal Financial.

With a lull in the equity market, fund houses spent this period expanding their portfolio of debt offerings. Alongside the plain-vanilla debt funds, came the gilt, liquid, cash funds and treasury management plans, to cater to high net worth and corporate investors. There was also a slew of balanced and hybrid fund launches.

During this period, assured return schemes from the UTI and the bank-sponsored funds were buffeted by controversy, after some reneged on promises. This was followed by the crisis in US-64. These events helped drive the concept of market-linked returns firmly into the minds of investors. And this put private sector fund houses firmly back on the radar screens of investors.

Restructuring pays off: The years from 1996 to 1998 saw equity funds restructuring their portfolios and piling them up with FMCG, pharma and infotech stocks. By end-1999, the secular bull run, led by the IT stocks, had helped many an equity fund build an impressive record of performance. But this "second coming" of equity funds was also to end in disappointment. The newfound fancy for equity saw the rollout of a slew of technology funds at the height of the bull markets in 2000. When these crashed, some of the goodwill painstakingly built by the equity funds also took a beating.

Debt in fashion: But, by then, private sector fund houses had managed to build up a strong performance track record in their debt products. Helped by the secular decline in interest rates and a basket of innovative offerings, mutual funds managed to deliver returns that were substantially higher than what was available from alternative savings avenues such as fixed deposits.

This led to a large-scale migration of assets to debt-oriented mutual funds.

By 2003, private sector mutual funds had wrested a lion's share of the mutual fund assets from the UTI and the PSU bank-sponsored funds. By end-December 2003, the mutual fund industry was managing Rs 1,40,000 crore of assets, with 80 per cent of it in private sector funds.

Swept by consolidation: The years from 1999-2003 saw a considerable churn in the industry. With competition intensifying, the weaker players were taken over. There was also a coming together of some of the larger fund houses.

The takeover of the Kothari Pioneer funds by the Franklin Templeton group and the Zurich funds by the HDFC group are instances. A few fund houses saw their foreign partners pull out, only to be replaced by new ones. Over the past couple of years, some of the big global names in financial services — HSBC, Grindlays and Deutsche Bank — have made an entry into the Indian fund arena. With US fund behemoth — Fidelity — now readying to enter the Indian market, the industry, at long last, appears to be reaching maturity.

Regulations stay in tune: Regulations have kept pace with the rapid changes in the industry structure over the past decade. Both the offer documents and the financial statements of mutual funds have been simplified over the years. Half-yearly portfolio and financial disclosures have been made compulsory.

Stringent investment norms have been put in place to prevent concentration and reduce exposure to illiquid and thinly traded securities. Disclosure requirements have been fine-tuned to reveal more about the pattern of ownership in a fund, and transactions with related and group companies. SEBI recently trained its sights on reforming the distribution and selling side of the mutual fund business.

Healthy competition: Intensifying competition has ensured that the fund houses have kept two jumps ahead of the regulatory requirements, at least on disclosures and service standards. Daily NAV is now a standard feature with funds, and transaction-processing times have been compressed to less than 48 hours.

Many funds have moved to a monthly disclosure of portfolios. Dissemination of information has leapfrogged with the use of websites for routine disclosures. Value-added services such as systematic investment plans, switch options, cheque-writing facilities, and call centre services promise to improve the investing experience for investors.

Savvy investors: As the equity market pauses after the secular bull run of 2003, equity funds appear to be back in the investors' good books. Hybrid products such as the MIPs (Monthly Income Plans) and equity funds have attracted sizeable inflows in the recent months. Is this a sign that retail investors are finally beginning to channel their investments in equities through mutual funds? Or, are they, yet again, falling into the age-old trap of jumping onto the bandwagon, in the late stages of a stock market rally?

It is early days yet to say which of these is true. But there are a couple of positive signals from the pattern of fund flows in the recent months.

For one, inflows have been pretty selective, a sign that investors are tracking fund performance far more closely than before.

Second, outflows from equity funds have also been rising, which suggests that investors are selling out when their target returns are met.

These are signs that mutual fund investors may be on to the two crucial skills for successful investing — a sense of timing and investment discipline; and that, too, at the same time.

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