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One Industry, Two Faces

The Indian fund industry is divided into two & the differences have given rise to irresolvable contradictions

There are two mutual fund industries in India and much of the anomalies that investors face (and the regulator tries to solve) arise from the fact that this dichotomy is not recognised for what it is. The goals, methods and motivation of these two businesses are so different that their very existence in the same structure gives rise to contradictions that cannot be resolved.

I’m talking of course of fixed income (debt) funds and equity funds. The theory is that these are merely two different asset classes in which mutual funds invest their customers’ money in. Depending on their needs, customers choose funds that offer various combination of debt and equities. This theory is true only to a very limited extent. While there are investors who fit this profile, the larger reality is different. The two very different worlds of mutual fund investing are those of wholesale debt investments on one side and retail investing on the other. Retail investing is almost entirely about equity with a little bit of debt, mostly in the form of various types balanced funds.

Wholesale debt investors are almost all businesses which have a need to park money for specific periods of time. Investment sizes are generally in many crores of rupees. The larger investors expect direct access to the fund managers who explain the fund’s strategies to them. All sales pitches are done in person either by the fund company’s or a distributor’s salesman. Investors expect to be kept informed about a fund’s portfolio. The very largest investors can also get ‘custom-made’ funds for specific investments they want to make. Like all wholesale businesses, this is a high volume, low margins business in which profits are in the regions of mere tenths of percentages of the assets that are being managed.

The curious thing about this industry is that a large proportion of it may not exist at all were not for a tax arbitrage between debt funds and bank deposits. Many of these investors just want a way of parking cash with predictable income. They choose mutual funds over bank deposits simply because the tax outgo in funds is lower. If this tax arbitrage were to vanish one day (and it can do so in any given budget), then the wholesale debt fund industry will have to reshape itself overnight.

However, the most importantly aspect of this business is that it efficiently manages to understand the customers’ real needs and fulfill them. Which is where the divergence with retail equity funds comes in. Equity funds are mostly retail products that are mass-marketed like a consumer product. Advertising and branding play a major role, as does a large army of small businessmen who go out and sell the products for a commission. While talking to fund company executives, I often get the feeling that their whole approach is an uncomfortable mix of what they do for debt funds with a smattering of consumer-product style advertising and brand-building.

Sure, fund executives do interact with equity investors but from what I’ve seen, these interactions are almost all with the richer, more risk-tolerant and returns-chasing kind of investor. The small investor who wants reasonable returns at a reasonable risk level never gets heard from. At Value Research, we get a huge amount of mail from this class of investor and I have no doubt that there are no effective channels of communication from them to the higher echelons of the fund industry. Unlike the assertive wholesale debt investors, these customers are faceless.

As a result, we have a fund industry that is well-designed to serve the needs of debt investors. When it comes to the ordinary equity investor, we mostly get some hackneyed assumptions and consumer advertising.