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Taking advantage of the Mutual Fund mania - Views on News from Equitymaster
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  • Aug 17, 1999

    Taking advantage of the Mutual Fund mania

    Newspapers are full of stories about the strong flow of money into mutual funds. That is not to say that mutual funds are a new way to invest in shares. Actually, mutual funds have been around for a long time - 1964, to be exact. That is when the Unit Trust of India launched its pioneering Unit Scheme 1964 and raised Rs 250 m. Today the Unit Trust of India has total assets of Rs. 533.2 bn and owns an estimated 7% of the stock market.

        Easy way to invest
    As an individual investor, it is difficult to monitor the trends in the fast-paced world of finance. Investing in shares and debentures is risky business and requires continuous monitoring of one's investments. This monitoring not only takes time, but also requires a fair bit of knowledge of financial terms and an understanding of the ever-changing economic environment within which the companies operate. An individual may prefer to invest his money into a mutual fund and leave the analysis and investment decisions to professionals. Qualified investment professionals are better equipped to analyze financial risks and opportunities. A mutual fund is a pool of money contributed by individuals who have similar financial goals. This pooling of funds enables investors to collectively increase their buying power. It also provides investors an opportunity to hire a professional manager to invest and monitor their money.

    From one to many

    As indicated, mutual funds in India have a long history. It all began with the setting up of the Unit Trust of India in 1964 but, due to the monopoly enjoyed by UTI, the controls on expansion for Indian industry, and the relatively quiet capital markets, there was not much growth in equity funds until the late 1980's. Companies seeking money to fund projects took loans from the financial institutions, the major suppliers of long term finance. At this stage of its evolution mutual funds had less avenues for making good investments.

    Growth in the sale of mutual funds units remained relatively slow until 1987 when public sector banks and financial institutions were allowed to launch their own mutual funds. Their entry led to an increase of inflows into mutual funds as new schemes were floated. This trend continued till the 1992 boom but, after the "1992 Stock Scam", investors preferred to stay away from the equity markets. The fact that many public sector banks were implicated in the scam also discouraged investors from investing money into mutual funds. Many of these funds had launched guaranteed return funds and, with the fall in the stock markets, most investors realized that these funds would not be able to make good their promises.

    The Regulator steps in, and so do the foreigners

    At this stage it also became apparent that the disclosure levels of mutual funds were limited, there was no uniform method of computing Net Asset Values (NAV's) and these were declared only annually. To instill confidence and to regulate the industry, SEBI notified regulations bringing all mutual funds except UTI under a common regulatory framework.

    Inflows into mutual funds spurted towards the end of FY1994 when private sector mutual funds were allowed to be set up. Foreign asset management companies also set up joint ventures to manage some of the domestic mutual funds. But this only gave the investors another reason to be disillusioned.

    Though the number of mutual funds had increased, investors were not educated enough to understand the functioning of a mutual fund and the tools to be used to evaluate a fund. Investors placed a high importance either on the reputation of the sponsor or on the performance of the market prices of its previous schemes while ignoring the NAV completely. Moreover mutual funds also failed to educate the investors about the characteristics of such investments. As a result investors equated mutual fund offerings with share issues by companies and expected large capital appreciation once these funds would be listed.

    For instance, Morgan Stanley collected Rs 9.8 bn in early January 1994. Investors were attracted to this fund because of the high pitch publicity with which it was launched and the general impression of it being " Made in America". Unfortunately, the "global vision, local knowledge" of many of these funds did not help the investors' returns.

    To be fair, the period of rapid expansion of mutual funds also coincided with a decline in stock prices. Also, since most mutual funds had made investments in smaller, less liquid companies, the values of their portfolios fell faster than the overall Index levels. Investors, hit by the 1992 scam, the lack of performance of the public sector funds and now the failure of the foreign funds, retreated from the capital markets completely. Confidence in fund managers eroded and investor perception turned increasingly negative. For most of 1996, 1997, and 1998 mutual funds found it increasingly difficult to raise new money from investors.

    Light at the end of the tunnel?

    The only way for mutual funds to raise resources was to focus on improving performances and offer better products and services. With increasing competition and easier regulations, mutual funds are making an effort to regain the confidence of the investors. Service has improved and more types of funds are being offered. Mutual funds are now offering schemes with features of reinvestment plans, systemic withdrawal plans, cheque facility for money market funds, and switchover facility between the schemes to suit investor preferences. Industry specific schemes are also available to the investors.

    Most mutual funds have beefed up their sales and distribution network. The disclosure standards of the offer document have been standardized to a great degree and funds are now required to make several important disclosures like past performance, dividends declared, and daily disclosure for NAV's. Investors are able to choose from schemes with different maturity periods that offer different risk-returns trade off. The tax incentives offered by the FY99 budget for equity schemes also led to an enormous increase in the flow of money into mutual funds. And the fact that the stock market has risen by 50% from its low of 3,055 in January 1999 has certainly helped!

    Mutual Funds in fashion again

    The result of all this has been a spurt in inflows. In FY99 inflows into mutual funds increased by 14% over FY98. The total amount mobilized was Rs 214 bn out of which Rs 97 bn (45% of total mobilization) was for 40 new schemes launched during the year. Total redemption in FY99 was also high at Rs 210 bn indicating that on a net basis there was hardly any addition to the total assets under management. Assets under management at the end of March 1999 was Rs 685 bn marginally lower than Rs 689 bn at the end of March 1998.

    However in the first quarter of the current year ending March 2000, mutual funds have mobilized over Rs 88 bn (an increase of 115% over the corresponding quarter of the previous year). With redemption of only Rs 43 bn the net inflow was to the tune of Rs 44 bn. As a result of the larger net inflow, the assets under management increased to Rs 780 bn as at the end of June 1999. Private sector funds have grabbed a higher slice of this pie than the public sector funds.



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