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Nse Sep 2009 Newsletter

Nse Sep 2009 Newsletter

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Published by Sunil Suppannavar

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Published by: Sunil Suppannavar on Nov 06, 2009
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Sept 2009
“Two roads diverged in a wood and I - I took the one less travelled by, and that has made all the difference.”- Robert Frost
The journey of mutual funds in India formally began way back in 1964 with the establishment of a public sector monopolyUnit Trust of India (UTI). It all began as a Government initiative to prod the small investor to savour the benefits of stockmarket investing in an affordable manner and inculcate a habit of financial saving as opposed to physical saving. UTI ex-isted till 2000 after which it was bifurcated into UTI Mutual Fund and Specified Undertaking of UTI, the former being regis-tered with SEBI. SBI Mutual Fund was the first non-UTI mutual fund established in 1987. This was followed by other publicsector mutual funds like Canbank Mutual fund, LIC Mutual Fund, Indian Bank Mutual Fund etc. Since the launching of KothariPioneer Mutual Fund in 1993 as the first private sector mutual fund, the industry has indeed come a long way. SEBI (MutualFunds) Regulations, which came into effect from 1993, detailed specific procedures to be followed for sale, distributionadvertising disclosure, compliance etc. Over the years, particularly in the later part of nineties, the industry has also gonethrough some degree of consolidation through mergers and acquisitions.In this article, various facets of the growth experience of the mutual fund industry are analyzed (
Exchange traded funds and fundof funds are not considered in this article
. Has the industry been successful in carrying forward the objective with which it com-menced? How has it developed and evolved over the years? What have been its unique selling propositions? Are the potentialinvestors spread far and wide across the length and breadth of this country aware of the existence of this industry? Havethe innovative products created by the industry served the purpose of the investors? How has the industry responded to thechallenges and opportunities confronting it? In the course of the analysis attempt is made to explore the answers to some ofthese questions.This article is structured as follows. Section 1 analyzes the importance of mutual funds in the portfolio of the investor vis-à-vis other competing financial products. This section also looks at the international experience in this regard. Section 2 de-liberates on the issues relating to regulation of the mutual fund industry. Section 3 analyzes the salient features of thegrowth of the industry over the last ten years. Using tenure based classification and investment objective based classifica-tion, this section will concentrate on relative performance of various types of mutual funds (open ended, closed ended, eq-uity oriented etc.) in asset mobilization, geographical penetration etc. It also looks at the degree of concentration in theindustry in the last four years. Section 4 deals with an analysis of the unit holding pattern of mutual funds and investmentpattern of mutual funds. Section 5 concludes after flagging various pertinent issues that confront the industry today.
Section 1: Status of the mutual fund industry
The ratio of mutual funds to total gross household savings, in India, increased from 5.5% in 1993-94 to 7.9% in 2007-08. Overthe same period share of deposits with banks have increased from 27.3% to 54.9%, share of insurance funds has increasedfrom 8.7% to 20.1% and pension funds down from 16.7% to 9.5%.
The author is Deputy Director, Ministry of Finance. He would like to acknowledge that discussion with Dr. K.P.Krishnan Joint Secretary,Ministry of Finance, Mr. CKG Nair Director in Ministry of Finance and Mr. Parag Parikh, Chairman Parag Parikh Financial Advisory Ser-vices were helpful in writing this article. Views expressed are personal.
By Anupam Mitra*
Sept 2009
Table 1
(at annex)
shows the distribution of gross financial saving of the household sector. It shows that, compared todeposits with banks, small savings schemes and insurance funds, stock markets in general and mutual funds in particu-lar have fared poorly. Only a small proportion of household savings goes into equities and debentures- 0.8% of GDPand about 12% of gross financial savings (2007-08). Per contra, 48% of household savings in the United States haveexposure to mutual funds. From the further discussion to follow will see whether the household sector has failed themutual funds or is it the obverse.The share of mutual funds as a percentage of GDP is 67% in USA and 83% in Australia. Again the contribution of mutualfunds to the growth of capital markets measured on the basis of mutual fund assets as a percentage of market capi-talization is 10% for India compared to 28% for UK, 81% for Brazil, 76% for France, 104% for USA, and 123% for Austra-lia. However the mutual fund industry is growing at a much higher rate in India as compared to the other major coun-tries. The Compound Annual Growth Rate over a period of ten years for mutual fund industry in India is 22% as com-pared to USA (5.7%), UK (6.6%), France (9.8%) and Australia (11%). This shows the tremendous scope and potential forgrowth of mutual funds in India.
Section 2: Regulation of Mutual Fund Industry
The industry is fully regulated by SEBI and governed broadly by the comprehensive SEBI Mutual Funds Regulations1993. Prior to SEBI taking over the reins of the industry, mutual funds were regulated through guidelines of the Minis-try of Finance and RBI.
Sadhak (2003)
argues that there were no regulatory guidelines for the mutual fund industry tillthe first such guidelines were issued by RBI in 1989 for mutual funds floated by banks. The Ministry guidelines empow-ered RBI to be the regulator of Money Market Mutual Funds (MMMFs) set up by banks. These guidelines, inter-alia setprecedence for regulation by entity rather than regulation by domain. The regulation also overlooked the inherentconflict of interest that the central bank would face in developing the money market (and indirectly its participantsincluding MMMFs) and the competition MMMFs could potentially pose to banks. The implications of this conflict of in-terest have been comprehensively examined by
Roy (2005).
In short, guidelines relating to lock –ins, minimum matur-ity periods for MMMFs etc ensured that banks do not face undue pressure. The Ministry guidelines also designated SEBIas the regulator of MMMFs floated by non bank mutual funds. Coordination of regulations issued by the two regulatorswas ensured by requiring SEBI’s guidelines for MMMFs to be in conformity with those issued by RBI. Dual parentage ofmutual fund industry ended in 2000 when all mutual funds were brought under regulatory jurisdiction of SEBI. Overthe years regulations have been strengthened and streamlined by SEBI, often as a response to market crisis to developthe market and protect the interests of the investors. The twin strands of reforms initiated by SEBI are stricter pru-dential norms (restricting parking of funds in short term deposits, stipulating stricter guideline for advertisements,removing discrimination on levy of exit loads etc.) and deregulation of operating environment (raising aggregate in-dustry wise ceiling for overseas investments by mutual funds in ADR, GDR, foreign security, overseas ETF; enablingshortselling etc).
Section 3: Growth of the industry
Over the last 40 years the mutual fund industry has seen impressive growth. The Asset Under Management of mutualfunds increased from Rs.18 crore in 1970-71 to Rs. 1, 53,802 crore in 2007-08. Since 1994 the number of mutual fundshas increased from 12 to 43 in 2008-09.
Sept 2009
The trend in gross resource mobilization by public sector mutual funds, private sector mutual funds and UTI since 1993-94may be seen in Table 2. The importance of UTI has declined since 2000 while the private sector mutual funds have rapidlyincreased their share.Mutual funds are classified based on tenure (open ended or closed ended) and also according to investment objectives (likeequity oriented, debt oriented, balanced, sector specific, exchange traded, fund of funds etc). The total number of schemes(excluding ETFs and fund of funds) offered by mutual fund houses have increased from 394 in 2000-01 to 974 in 2008-09. Ta-ble 3 gives an overview of the various types of mutual fund schemes classified both according to tenure and investment ob-jectives. It is a debatable issue whether in a mutual fund scheme the investor should be given the option of free exit orshould he require getting himself replaced by another as in the case of a share of a company
(Sethu 2006).
Thus an openended scheme treats the investor as a “customer” while a closed ended scheme treats him as a “shareholder”. Table 3 showsthat the proportion of open ended schemes increased from 63% in 2000-01 to 90% in 2004-05. Since 2005-06 the proportion ofopen ended schemes has declined from 78% to 58% in 2008-09. While it is true that fund houses have offered various tailormade schemes to suit risk return profile of a wide spectrum of investors it still appears that there are too many very similarkind of schemes. Perhaps to bring in more discipline it may be worth considering a suggestion made by Dr. Tarapore of link-ing the number of schemes to net owned funds (
Tarapore 2009 
). The decision whether to let a particular fund grow larger orto start a new fund should not be guided by the differential between the commission on new funds and trail commission onexisting ones. From Table 4 it is seen that more than 75% of the asset base of the mutual fund lies in debt schemes, withequity oriented schemes accounting for about 20%, the balance left for hybrid schemes.Money market mutual funds (MMMFs) are defined in SEBI regulations as “a scheme of a mutual fund which has been set upwith the objective of investing exclusively in money market instruments” where money market instruments includes“commercial papers (CP), commercial bills, treasury bills, Government securities having an unexpired maturity up to oneyear, call or notice money, certificate of deposit, usance bills, and any other like instruments as specified by the ReserveBank of India from time to time”. The advantage of MMMFs is that they enable a retail investor ( who do not have easy ac-cess to T-Bill , call lending, CP, either due to high denomination or lengthy , cumbersome procedures) to enjoy money mar-ket yields . It may be noted from Table 5 that the implicit cut off yield on 91 day treasury bills as well as average weightedcall/ notice money (proxy for money market yields) rate is far higher than savings bank deposit rates.As seen from Table 5 AUM, under liquid /MMMF as a proportion of AUM under all debt oriented funds has consistently in-creased from 7% in 2000-01 to 51% 2004-05. The decline since 2004-05 could be attributed to the Bull Run in the equity mar-ket as captured by Nifty.Despite the large number of mutual fund houses, the top five mutual fund houses account for 56% of the AUM whereas thetop ten mutual fund houses account for as much as 78% of AUM in 2009. There is counterintuitive evidence of increasing con-centration despite increase in number of players as seen from Table 6. The spatial distribution of Mutual Funds Investors isvery skewed towards urban areas. As can be seen from Table 7, 71% of Mutual Fund investors accounting for 86% of net as-sets of Mutual Funds belong to urban areas. Public Sector Mutual Funds have a relatively greater penetration in rural areas.

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