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Retail investors' participation in equity funds is improving

Management consulting firm Boston Consulting Group

Management consulting firm Boston Consulting Group (BCG) along with Computer Age Management Services Pvt. Ltd. (CAMS), came out with a report on equity mutual funds titled, Equity Mutual Funds: Charting your Course with a Compass. According to it, the Indian equity mutual fund investor has matured and investors are increasingly considering and accepting mutual funds as an instrument of savings.

Retail investors flock to equity
The report states that National Accounts published by the Reserve Bank of India (RBI) indicate that the share of mutual funds in household savings has increased to 7.9 per cent in FY2008 from less than 1.1 per cent in FY1994.

Retail products such as systematic investment plans (SIPs) and equity linked savings scheme (ELSS) are increasingly gaining traction with retail investors. These products are helping the industry rope in small investors and investors from outside the top 10 cities.

According to the report, 'retail' investors dominate the equity assets under management (AUM). What's encouraging is that investors seem to prefer long-term investments. The preference for long-duration assets may reflect the growing importance that retail investors attach to equity mutual funds as a savings tool. The popularity of ELSS and SIP has also contributed to the enhanced duration of equity AUM.

In spite of differences in the organisation and structure of various distributor types, there is similarity in AUM investment tenure across distributor types. This implies that customer behaviour is independent of the distributor. Possibly, an average investor makes entry and exit decisions based on his or her understanding of the market and personal choice. This again augurs well for the industry because it suggests that investors are getting knowledgeable and have a mind of their own.

  • Investment volume by different ticket sizes of investment: Over 90 per cent of the investment volume is in ticket sizes of less than Rs 1 lakh, and nearly 99 per cent of the investment volume is in ticket sizes of less than Rs 5 lakh.
  • Share of AUM by value: Nearly 40 per cent of AUM is through ticket sizes of less than Rs 1 lakh, and nearly 60 per cent of AUM is through investments in ticket sizes of less than Rs 5 lakh. The remaining approximately 40 per cent of the AUM is through ticket size investments of greater than Rs 5 lakh.

Investment duration
Interestingly, or rather obviously, there are significant differences in investment duration by type of investor. While average tenure across the industry is about 30 months, retail and mass customers have a longer tenure AUM than high networth individuals (HNIs). Small-ticket-size investors account for a large part of ELSS and SIP investments, which are inherently long term. Most of these investors are likely to have done their own research and are comfortable investing in products for a longer duration.

More importantly, return expectations of these investors are likely to be different from the expectations of larger-ticket-size investors, HNIs. The latter also have access to sophisticated and active advice and thus are able to re-allocate their portfolios faster generally without even getting involved in the choice of specific schemes.

  • Average tenure for equity money is about 30 months. Nearly 50 per cent of the AUM has tenure greater than 2 years.
  • Retail investors have longer holding duration than HNIs. In case of investors with ticket size less than Rs 1 lakh, 79 per cent of their investment had a duration of over 12 months. By contrast, in case of HNI investors with ticket size over Rs 100 lakh, only 45 per cent of their investments had a duration of over 12 months.
  • The average tenure for the retail segment with investment ticket size of less than Rs 1 lakh is about 33 months while that for the HNI segment with investment ticket size greater than Rs 100 lakh is about 20 months.

Profitable or not?
Equity investors on the whole have made money from their investments, but less from new fund offers (NFOs). The report analysed the total redemption in equity mutual funds over the past two years (April 2008 - March 2010). The analysis showed that over 72 per cent of the redemptions were at a profit, with only about 28 per cent at a loss - even during a generally turbulent period. Hence, investors on the whole have stood to gain from equity mutual fund investments.

In the case of retail investors (less than Rs 5 lakh investment ticket size), the percentage of customers redeeming at profits is greater than 80 per cent, while for HNIs (greater than Rs 5 lakh investment ticket size) the percentage is approximately 63 per cent.

A few hypotheses could explain this trend. Firstly, small investors are less risk averse and have the patience to hold on to their investments even during bad times. Secondly, they have likely invested for a longer duration giving themselves a larger window of opportunity to redeem at profit. Unlike retail, for HNI investors, market uncertainty and active management could be the main reasons for the comparatively larger proportion of redemptions at losses.

  • Though investors' experience is significantly different with redemption from NFOs, out of the approximately Rs 7,000 crore redemptions over the same 2-year period, only about 50 per cent of that volume was redeemed above par value.
  • in the remaining 50 per cent redeemed at profit, nearly 22 per cent was redeemed at a net asset value (NAV) of less than Rs 11, implying a return of less than 10 per cent. Thus we infer that investors' experience within NFO redemptions has not been encouraging.

Equity inflows
Though conventional wisdom would suggest a high correlation between inflows in a scheme and its long-term performance, equity inflows are not linked to scheme performance and overall market movement.

A comparison of the long-term returns (5 year) of select schemes (similar investment objective) with the inflows in those schemes in the following year, revealed no correlation.

This is quite intriguing and seems to imply that once a scheme belongs to a particular set, then either investors do not fine-tune their choice or they are more comfortable with other factors such as brand image of the asset management company (AMC).

The report then attempted to establish a correlation between the change in gross inflows and change in the market, using the Nifty as a proxy for the market.

Out of the 82 months plotted, for 50 months the direction of change in gross inflow, lagging by a period of 1 month, was in the same direction as the change of Nifty and it was the opposite for 32 months. With a very poor R2 of 8 per cent, it was safe to assume that there is no meaningful correlation between gross inflows and market movement. However, during 'exuberant times', investors are willing to be more open to investing in equity mutual funds. An interesting perspective was that there appeared to be a floor in the negative change in gross inflows. Irrespective of the sharp drop in Nifty, the inflows don't drop beyond a certain level. This may be happening because of increased subscriptions to SIPs and value buying by investors at time of dips.