Citi reveals promise of Indian Mutual Funds in Report

Citi has claimed India to be “Asia-Pacific’s next Mutual Funds giant” in a new report, naming the country’s massive population, 24 regulated stock exchanges, embracing of technology and diverse array of businesses as creating the potential for India’s mutual fund industry to flourish.

In the report, Citi stated that India is set to become one of the world’s top-three economies globally in the next 20 years, with its population projected to exceed 1.66 billion by 2050. Domestically, over 110 cities have been named as wealth centres.

However, Mumbai and Delhi are the site of almost 50% of the country’s mutual fund sales, with only 1.5% of the country’s population owning a mutual fund. This is significantly lower than the 44.8% of households owning a mutual fund in the USA in 2018, as stated in a Statista report.

India, despite its current low mutual fund ownership and patchy penetration trend, is set to harbour over 500,000 families with over USD3.5 million in wealth by the year 2025, making the country a promising proposition for wealth managers, as currently in 2019 only 25% of these families’ wealth is being professionally managed.

While the Unit Trust of India was first created in 1963 by the Reserve Bank of India, public sector banks and insurance companies were only allowed to introduce their own mutual funds in 1987, and foreign entities only entering the market from 2006 onwards during what the Citi report has entitled “Phase 6.”

The introduction of foreign players into the Indian market saw the market develop significantly over the subsequent years in all aspects of financial services.

Although the success of foreign entities in the Indian market has been inconsistent, with some joint ventures between foreign and domestic firms resulting in failure, with many not gaining the anticipated faster returns from the Indian ventures, especially when the market was compared to the falling margins witnessed in many global markets.

Citi, however, has reinforced the potential of the Indian market, quoting the projected growth of the country’s economy and young population as harbouring massive potential.

The lack of external investment by domestic entities and the limited existing retirement provision in the country have been named as prominent opportunities for foreign firms. However, the challenge of breaking into and growing in the inward-looking Indian market remains difficult to overcome.

Nirmala Sitharaman, India’s finance minister, has even announced the country’s intent to “redouble efforts to regain inward-focused momentum,” according to a report by the Indian Economic Times, as part of a reaction to the USA-China trade war.

Citi has revealed that the go-to strategy by foreign firms to overcome this inward-focus is to allow their local operations to function as independently as possible, with many firms appointing market heads sourced from the country itself in order to meet the country’s expectation for localised entities.

Many foreign firms are keen to employ local staff, manage Indian products, and ensure that, as much as possible, its local people selling to local people. This is what differs the Indian market from many other countries in the region.

The Indian mutual fund business has also been described by Citi as “very retail,” meaning that firms may find the process of accumulating the necessary level of assets to make the local operation profitable more time consuming than anticipated.

2016’s demonetisation, which saw the introduction of new INR500 and INR2,000 banknotes in an attempt to end instances of illicit economic activity, in itself triggered an increase in the number of retail investors operating in the market and provided a significant boost to mutual funds.

The boost came due to the fact that mutual funds were seen as an alternative avenue to holding wealth alongside cash, with the country’s shortage of physical banknotes triggering a need for alternative arrangements following the demonetisation.

This necessity led to a 32% increase in the AUM of the mutual funds industry following the demonitisation; this increase was maintained over successive years, complemented by the strong industry growth seen over the 2017-2018 period.

In 2018, SEBI sought to reduce the interchangeable nature of the term “mutual fund” in india through the consolidation of regulations and guidelines for mutual funds companies.

SEBI broke down the term mutual fund into distinct categories, comprising of Solution oriented schemes, Hybrid schemes, Debt schemes, Equity schemes and other schemes, and sought further uniformity through the categorisation of the investment universe according to market capitalisation of stock exchange-listed companies.

The regulator introduced a further 10 subsector categories for equity schemes, 16 for debt schemes and 6 for hybrid schemes. It additionally introduced regulations regarding the issuing of fees, charges, expenses & comissions, and the investment restrictions applicable to Indian mutual funds.

SEBI also introduced sub-classifications for other schemes (index funds & ETFs, and overseas & domestic fund of funds,) and solution-oriented schemes (there is a split between retirement funds and children’s funds.)

The total value of the AUM in the top 5 Indian funds has been reported as exceeding USD43 billion. ETFs, which were first made available in 2001, currently have a total AUM of over USD20 billion, with gold and equity funds remaining the most prominent choices for Indian investors.

However, Citi has stated that the adoption of ETFs remains limited in the market, with foreign-investment ETFs being strangled by existing foreign exchange restrictions; only USD244 million of the total ETF AUM being invested in foreign funds.

Furthermore, although the number of alternative investment funds available in India is growing, the accessibility to these funds in limited to, generally, a 1,000-investor cap-per-fund, with only HNWIs having access.

The fact that distributors of alternative investment funds in India can also demand up to 10% of the investment value in upfront fees has also hindered these funds; some have begun to call on SEBI to introduce more restrictive regulations on how these funds operate, in order to prevent the potential collapse of some funds from having a significant impact on the market overall.

Despite the potential shortcomings of some aspects of the Indian mutual fund market, Citi has revealed the popularity of Systematic Investment Plans, which is a form of regular savings plan which buys directly into investor-selected mutual funds.

These SIP plans have become successful following the stressing of benefits such as rupee cost-averaging, convenience and compounding by mutual fund distributors and fund houses; all Indian fund houses offer these products and bank distributors are strongly encouraged to use them with customers.

SIP structures also allow investors tax advantages when engaged alongside the Equity Linked Saving Scheme, a tax-saving mutual-fund product with a three-year lock in period where individuals can save up to INR46,800 in a financial year, and are only taxed at 10% only on the excess over INR100,000.

Portfolio Management Services have also seen significant growth, with over 280 news firms having registered to service HNWIs. Over 130,000 clients are part of this sector, with PMS becoming the fastest growing sector in the market, offering an alternative to traditional mutual fund investment.

The report goes on to describe the existing pension and retirement funds, and institutional fund management offerings, naming the tax-exempt National Pension System as having the potential to offer options to HNWIs.

In 2018, the government made the National Pension System entirely tax-free upon maturity, with the 40% annuity also became tax-free. The structure of the National Pension System, unlike traditional financial products, follows an unbundled architecture. This means that each step of the value chain is made separate from the other, thus allowing the customer to create the best suited structure for them, as they can mix and match their providers of service.

Citi closes the report by pondering the feasibility of engaging the entirety of such a large market of potential investors. It expresses that, while the Indian mutual funds market presents complicated challenges, it also harbours extensive opportunities in its scale.

The youth of the mutual fund industry, as only recently has it become a serious prospect for retail investors, with the option of using regular savings plans to accumulate assets and wealth becoming an increasingly acknowledged and utilised strategy.

Based on the growth witnessed in the past decade alone, Citi has reinforced the potential in the market for foreign firms, with only 2 of the country’s top 10 largest mutual funds companies being 100% locally-owned.