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While the Indian Mutual fund industry has come a long way since its inception, there are certain areas of concerns which need to be addressed in order to grow at the rapid pace. The factors that could turn out to be the major impediment going forward are: low levels of customer awareness, unwillingness to undertake even minimal risk, inadequate reach of funds/ distributors to retail investors, limited innovation in product offerings, limited focus of the public sector network on distribution of mutual funds, multiple regulatory frameworks, and competition from assured return products like Government of India bonds, post office monthly income schemes, senior citizen savings schemes, national saving certificates, etc.

Low level of Customer Awareness

As noted earlier, low levels of customer awareness is the biggest challenge in channelizing household’s savings into mutual funds. A majority of investors in Tier 2 cities as well as metros lack understanding of mutual fund products and can draw little distinction in their approach to investing in mutual funds and direct stock market investments. As a result, they are generally unwilling to undertake even minimal risk.

Inadequate reach of funds / distributors to retail investors

The mutual funds in India have historically raised funds by targeting the institutional investors segment that accounts for 63% share in AUM as at March 2008. This can primarily be attributed to the tax arbitrage available to corporates on investing in money market mutual funds and easy access to institutional customers concentrated in Tier 1 cities. Besides, raising funds from retail investors require a significant distribution capability. The Indian Mutual fund industry has limited penetration beyond the top 20 cities. In fact, the retail investors residing in Tier 2 & 3 towns, though aware and willing, are unable to invest in mutual funds due to limited access to suitable distribution channels and investor servicing. However, with the deepening of the global financial crisis, many mutual funds witnessed sudden redemption pressures due to their dependence on institutional AUM. This is expected to lead AMCs to start focusing on retail investors’ segment.

Limited innovation in product offering

Though over the years, the Indian Mutual fund industry has introduced a range of products, it has limited focus on innovation and new product development. It is still to launch green funds, socially responsible instruments, fund of hedge funds, enhanced money market funds, renewable and energy/ climate change funds, etc. Multi-manager funds that are among the most hybrid funds world-over have also not grown in India due to the prevailing tax structure.

Multiple Regulatory Frameworks

Besides, multiple regulatory frameworks governing financial services sector verticals have affected the Mutual fund industry in India. For instance, the mandatory PAN card requirement for an investment of Rs 50,000 and above in mutual funds has restricted the Mutual fund industry’s ability to tap small investors. On the other hand, Unit Linked Insurance Plans (ULIPs) which is a competing product do not have the mandatory PAN requirement. In addition to the PAN card requirement, the customers are required to procure KYC acknowledgement which requires submission of several documents and an extensive paper-work.

Moreover, while the payment for investment into mutual fund is required to be made only through banking facility, no such requirement exists for ULIP. These complicated regulations restrict potential customers from investing in mutual funds. Further, this calls for an urgent need for government to harmonise policies and processes across different verticals in the financial services sector.

Future Outlook

The low penetration level of domestic AMCs as well as limited share of mutual funds in the household financial savings point towards the future potential of the Mutual fund industry in India. Further, given the rise in income levels and household financial savings, an increasing number of households are expected to invest in mutual fund products that yield higher returns with reasonable risk. The continuous process of urbanisation, enhanced financial literacy and a huge young population with an increased risk appetite are also likely to be instrumental in the long term growth of the retail segment of the Mutual fund industry. Further, the public sector network of nationalised banks and post offices are likely to increase their focus on the distribution of mutual funds in Tier 2 and Tier 3 towns. This will enhance the reach of mutual funds to the rural population.

In case of institutional segment of mutual fund, rising corporate earnings, maturing capital markets and increased demand for sophisticated treasury management products are expected to play a key role in accelerating the growth of the Indian Mutual fund industry. Profitability of the Mutual fund industry in India is expected to witness a gradual decline as AMCs’ focus on low margin products to attract risk-averse investors will affect revenue generation. At the same time, AMCs’ focus on increasing their penetration in rural population beyond Tier 2 cities will lead to increase in operating costs.

Furthermore, with the entry of global players, competition for the domestic mutual funds is expected to increase. In view of the intense competition and shrinking margins, the industry is likely to witness some consolidation as AMCs will review business strategy and explore exit/mergers in case of no significant competitive advantage.