Rama Krishna Vadlamudi, BOMBAY

www.scribd.com/vrk100

January 11, 2010
vrk_100@yahoo.co.in

MY BLOG: www.ramakrishnavadlamudi.blogspot.com
This is a curious case of equity mutual fund investors’ encashing their investments even as Indian stock market has gone up in the last five months. Mutual funds seem to be finding it difficult to manage the changed business environment after the capital market regulator, Securities and Exchange Board of India, banned entry loads on mutual funds with effect from August 1, 2009. The following table will give you a better idea about the redemption pressure in equity mutual funds in India between August and December 2009: REDEMPTIONS/REPURCHASES (Rs crore) Net Outflow
From August to December 2009

Net Inflow
From January to July 2009

(7,315)
Data source: AMFI

7,432

Equity MFs

As can be seen from the above table, between August 2009 (when SEBI banned entry loads) and December 2009, the net outflow from equity mutual funds is Rs 7,315 crore; whereas, net inflow into equity mutual funds is Rs 7,432 crore between January and July 2009. The ban on entry loads seems to have caught the mutual fund industry off-guard. The criticism leveled against the mutual fund industry is that their business model till July 2009 was distributor-driven at the cost of individual investors. All these 15 years, they were doing their fund business in a particular way. The entry-load ban by SEBI has changed their business complexion completely. But, the industry is yet to come to grips with the situation. As insurance products (Unit-Linked Insurance Plans, or, ULIPs) are more attractive for distributors, they seem to be pushing ULIPs instead of equity mutual funds. Even though IRDA has changed the structure of ULIPs recently, distributors still find ULIPs more attractive for getting their share of commissions.

Rama Krishna Vadlamudi, BOMBAY
www.scribd.com/vrk100

January 11, 2010
vrk_100@yahoo.co.in

MY BLOG: www.ramakrishnavadlamudi.blogspot.com
It is interesting to see how mutual fund industry would realign itself in view of the changed circumstances. The time has come for them to focus on customer acquisition, which is very expensive in the absence of entry loads. Due to the ban on entry loads, mutual funds are finding it difficult to raise new fund offers (NFOs), through which they used to rake in substantial amounts of funds. The net assets of equity mutual funds were growing phenomenally mainly due to the NFOs. Now, the NFO route is not possible due to the entry load ban. More curious is the behaviour of equity mutual fund investors. Let us consider the movement of stock market indices between August and December 2009:
INDEX 31-Dec-09 Points SENSEX MIDCAP BSE-200 17 464.81 6 717.82 2 180.25 Growth over 31.7.09 % 11.50 20.60 14.20

From the above table, one can observe that the Sensex has given a positive return of 11.50 per cent against 20.60 per cent by BSE-Midcap index, between July 31st, 2009 and 31st, December 2009. The BSE-200 broader index has recorded a return of 14.20 per cent during the same period. This clearly indicates that even though the stock markets have gone up steadily in the last five months, investors have preferred to encash their equity MF investments, with net outflow of Rs 7,300 crore (as shown above). Before August 1, 2009, if you invest Rs 10,000 in an equity mutual fund, the Asset Management Company or AMC used to charge 2.25 per cent or Rs 225 from your money toward entry load and the remaining Rs 9775 (10,000 – 225), they used to invest in equities and allot units to you. Now after the entry load is banned, if you invest Rs 10,000 in an equity MF, the entire Rs 10,000 will be invested in equities and units will be allotted, based on the prevailing Net Asset Value, to you for the entire Rs 10,000. Which means, now MF investors will be saving Rs 225 or 2.25 per cent of their money. This is a substantial benefit to MF investors. But, investors are selling out their investments instead of putting more money in mutual funds; even though they are saving up to 2.25 per cent of entry load.

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Rama Krishna Vadlamudi, BOMBAY
www.scribd.com/vrk100

January 11, 2010
vrk_100@yahoo.co.in

MY BLOG: www.ramakrishnavadlamudi.blogspot.com
The reasons for the strange behaviour of investors are attributed mainly to: 1. The entry load ban by SEBI wef August 1, 2009 2. Regulatory arbitrage in favour of ULIPs driving distributors towards insurance products 3. Equity investors see the raise in indices as an opportunity to sell out and make small profits in the process. They still seem to be afraid of the panic situation that prevailed in 2008, when equity investors have lost very heavily.

SUMMING UP:
The entry-load ban by SEBI seems to have broken the back of mutual fund industry; as far as raising money through equity new fund offers is concerned. The distributors find it unattractive to push equity mutual funds and instead they are turning towards ULIPs. Equity mutual funds have become cheaper by 2.25 per cent compared to previously. As such, investors would be better off putting in more money into equity mutual funds according to their risk appetite, asset allocation and convenience taking their long-term interests into consideration. It’s time for them to invest based on the following considerations: 1. Long-term track record of three or five years of the particular fund; 2. It is a myth to assume that NFO with Rs 10 net asset value is better than an existing fund with an NAV of Rs 100 or more. The NAV of Rs 150 (of a fund with growth option) indicates that the fund started with an NAV of Rs 10 and since inception its value has grown by 15 time. For example, the present NAV of Reliance Growth fund (growth option) is Rs 437. It indicates that the NAV of this fund has gone up by 43.7 times since its inception in October 1995. Its annualized return (CAGR) since inception is 30.32 per cent!; and, 3. See the track record of the fund manager also whether she is able to protect your money during any downturns. The fund manager should be able to generate sustainable performance – not only during bull markets but protect our money during bear markets as we have seen in 2008. If you select your equity funds based on the above time-tested principles, you are likely to generate decent returns provided the India Growth Story is intact for the next five to ten years.

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