The Indian mutual fund industry is at crossroads with the asset managers struggling to keep their heads above water. Barring some, the majority are faced with the seemingly insurmountable challenge of raising profits at a time when running costs have spiraled and dwindling sales have impaired revenues.
Over the last three years, the business landscape has undergone a radical transformation. The ‘no-load regime’ has almost overnight changed the rules of engagement among industry participants. Going by industry equity sales data, the attempted transition from a commission- to an advisory-based model has not been easy. A stubbornly under performing stock market of the last three years has also been agonizingly ill-timed.
Despite an over-pervasive sense of despair, the opportunities for the industry and its players are immense. India’s favourable demographics, high savings rate and low household penetration signify enormous potential for future growth. While the long term holds ample promise, the real challenge lies in the near term.
In the bull market of 2004-07, growth was easy and aplenty as investor exuberance hit a new frenzy. NFOs mobilized record subscriptions leading to exponential top line growth. Expenses incurred on brand building, marketing and distribution of up to 6 per cent were then allowed to be charged to the scheme and amortized over a period of five years putting little pressure on AMCs’ P&L. A gestation period of three years was considered enough to breakeven then. Not anymore.
Today any spend beyond the permissible scheme recurring expenses, which are charged to the investors, has to be picked up by the AMC. People costs, which had escalated during pre-GFC period, have since been rationalized with productivity and performance coming under intense scrutiny. The cuts in the marketing budgets of most have also been severe, forcing them to opt for non-conventional lower-cost options. While some relief has come from possible adjustment of such marketing expenses from the balance lying in the scheme load account, the newer entrants may not have sufficient build up for meaningful utilization. Nonetheless, the penal charge imposed in the form of exit load for investors redeeming before the stipulated period helps AMCs cover up a portion of the costs incurred for client acquisition. In a heavily under-penetrated country, investor education and awareness holds the key. With marketing budgets coming under pressure, AMCs will increasingly have less room to maneuver.
Post abolishment of entry load, AMCs have been paying front end commission to distributors from their own pockets which is generally more than the annualized fees that they earn. In such cases, AMCs can hope to breakeven if the length of investment is long enough to match the fees earned on an annualized basis with the commission that was paid up front. This can only happen if investors don’t exit either on their own or based on advice before the stipulated investment period. With an industry breakeven hold period of 18 months and a high churn ratio, a solution will remain elusive unless AMCs and distributors need to come together to decide on a best practice. It is common sense that distributors of products need to be paid for their service in order to make their business commercially viable. The key is, in what form and manner.
Despite rising expenses over the last few years, AMCs of practically all stripes have been implementing a variety of cost reduction measures, making them today a lot leaner and more cost efficient. That considered, improvement in bottom-line from here can only happen with growth in sales and higher revenues.
The industry is yet to adapt to the universal practice of selling mutual funds in the form of multiple share classes. Broadly, Class A have front-end load but no exit load, Class B have no front-end load but carry CDS and Class I have low to nil entry and exit load and are meant for institutional investors.
Globally, no-load funds are popular among self-serving investors and are usually bought directly by investors or through low-cost platforms but rarely through distributors. Aligning to multiple share classes may be a win-win for all the three stakeholders, most importantly the investors as they would have a wider option to choose from among different share classes.
Recent regulatory reforms have indeed been path breaking and have opened up huge windows of opportunity for potential future growth. Allowing foreign investors to participate through the mutual fund route has paved the way for sizeable inbound investments from global pension and endowment funds, insurance behemoths and family offices to allocate long-term funds to domestic schemes once the technical hurdle for segregating expense structures for retail and institutional categories is sorted out. Introduction of share classes under the QFI route may be the ideal way to go. The other giant step of permitting local fund managers to manage offshore funds having similar investment objectives and 70 per cent portfolio replication will lead to significant synergies in costs and resources and open up new revenue streams for the players. A lot, however, will depend on how smartly the industry can adopt to the new order.
Notwithstanding that, sponsors and promoters of AMCs, both foreign and local, can take solace from the fact that they cannot go wrong in a market like India as long as they have reasonable patience and abundant passion.
(This column has been written by Arindam Ghosh, ex-CEO Mirae Asset. Author’s views are personal)
NFO: New fund offer / AMC: Asset management company / P&L: Profit and loss account / GFC: Global financial crisis / CDS: Contingent deferred sales charge / QFI: Qualified foreign investor