Make no mistake about this – the mutual fund industry is booming. Every fund house is making a lot of money – or is hoping to make a lot, lot more money in the near future and hence the rush for new fund houses to be set up. We are still not seeing any major mergers and acquisitions – but we are seeing the foreign fund houses run away because of some archaic rules.

Why should a Fidelity have a FULL FLEDGED INDIAN office to be able to sell mutual fund schemes in India to sell to Indians? Why cannot Fidelity just have a sales office in India and give us the benefit of their research on Indian markets – while being based in Hongkong? Maybe even sell online? Ok, in Economic parlance, lets call it the Mumbai Club. So even if Vanguard were to come to India and start operations, the regulator will make sure that they cannot come out with their legendary 0.025% kind of charges in the near future. Amfi ki jai ho. The Indian manufacturer is well protected, long live mutual fund industry.

The SIP sales is booming and if the 1 crore sips can grow at 10% and the average sip size can also grow at 10% from the current average of Rs. 3200, the mutual fund industry is sure to have enough business to keep growing for some more time.  Mutual-fund companies focus far too much (even the word all will not be wrong) of their energy on “asset-gathering,” trying to grow as large as possible as fast as possible.  Mutual funds added 1.64 million folios from the quarter ended September to reach 50.6 million in the December quarter, according to Association of Mutual Funds of India (Amfi). Compared to the same quarter a year earlier, folios rose 6.97 million, or 15.2%.

They are just responding to the way they are being currently compensated. The needs of existing investors — decent performance at fair fees — are surely neglected in order to serve the managers’ (including the independent sales force) own needs: chasing unsustainable performance to lure in new investors, increase aum, create a huge unnecessary array of schemes – with perhaps the dubious business of to maximize fees. The money flowing into funds has hit tsunami heights – the increasing number of new online sales models (each well funded by Vee Cees or having deep pocket investors).

As the industry gets bigger, the fund charging structure has remained stuck in 1994/5 when the fee structure and limits were set. Not sure when the numbers were visited again. The regulator’s only (repeat repeat) job should be to ensure “good fund performance at a reasonable fee”. So reducing TER or even denying some portion of the fee for poor performance should be possible. As of now it is not happening. The regulator instead seems to be fighting a battle with the weakest link in the chain – the IFA and the distributors in general. Coming out with concepts like SOA (Statement of Advice), Client-IFA agreements, Schedule of fees – or at least getting the mutual fund distributors to create these statements (face it, it is just a cut paste from USA or Australia) should be a far more interesting and important work than what it is currently doing.

Why is the increasing size of a single fund a problem? Well simply because of the shallow depth of the equity market that we have. When was the last sensible well priced IPO? I cannot blame you – but remember the year 2016 was a boom year in the primary offerings. The bloated mutual fund industry hardly applied its brain while applying for allotment. Mutual funds buy shares of insurance companies is such an amazing proof that the fund gathering business (aka amc) is lucrative for everybody.

Talking of TER – why is the fee a percentage? and why is that such a holy cow? If the mutual fund ‘business’ has to develop as a ‘profession’ is it not enough time that the fees to be charged be capped much, much tighter? Sponsors (shareholders, promoters, owners) get richer as funds get fatter – so, the fund industry has no incentive to correct the problem (they do not even admit it is a problem) — and the regulators are not even seeing this (nor equipped?) to resolve the issue, either.The fund house incurs expenses which are fixed and partly variable, however it has an amazingly profitable revenue model -WHERE THE WHOLE CAPITAL RISK is borne by the investor (unit holder, not the shareholder of the fund). Its time that the revenue model is tweaked.

Why am I cribbing about the increasing size of each scheme? If  XYZ fund tried to buy or sell  huge blocks of small stocks (we have a notoriously shallow market), it could single handedly create a demand supply mismatch — raising the price it pays to buy or depressing the price it gets on sales. That’s called market impact! We saw one fund house (not known for any vision or leader like behavior) struggle with a few scrips – and this can wreck a fund’s performance. Only way to avoid this problem is to buy bigger shares — those with a greater outstanding share value. Today the market value of many fund’s average stock is much more than 10 times larger than in say 2000. Now imagine this in a mid-cap portfolio. Hey, where is the market depth?

Index funds, ETF, Robo advisory, investor clubs, are all a likely threat to the mutual fund industry. The regulator of course will keep going out of his way to protect the Bombay club, but allowing the real big fund houses with a minimal Indian infra will allow Indian investor access the fund managing capabilities, of the real big fund houses – and we will see the Indian fund houses suddenly being exposed as expensive bastions with full protection to invest in 100 odd companies (equity) and about 200 odd bonds, most of them issued by the government.