Mutual Fund Wars: Increasing Competition Might Be Good For Investors, Not For Asset Management Companies

Mutual Fund Wars: Increasing Competition Might Be Good For Investors, Not For Asset Management CompaniesMutual funds
Snapshot
  • While consumers are likely to benefit from the increasing competition in the mutual fund space, asset management companies might witness a period of lower fees and profits.

Bajaj Finserv, the parent company of Bajaj Finance, recently received an approval from the Securities and Exchange Board of India (SEBI) for setting up a mutual fund house.

In the past few months, a number of companies have applied for licences to set up mutual funds. Clearly, it isn’t just retail investors who want a slice of the stock market boom in India.

A majority of the older asset management companies (AMCs) were set up by banks, financial institutions, or large industrial houses. But the new entrants have unconventional backgrounds.

India’s largest mutual fund distributor, NJ India Invest, has set up its own mutual fund. It is probably the only mutual fund distributor to have taken this step. The fund would be focused on passive investing strategies.

Samco, a discount broker, has also set up its own mutual fund business after running a successful discount brokerage business.

India’s largest brokerage, Zerodha, is looking to set up an AMC. It has already ventured into the asset management business with True Beacon, an alternative investment fund.

PhonePe has reportedly received an approval from its board and will soon apply for a mutual fund licence. Paytm and MobiKwik are also said to be looking to set up their own AMCs.

Groww, a digital mutual fund broker, has already taken the acquisition route to build its mutual fund business. It recently acquired Indiabulls Mutual Fund for Rs 175 crore.

Similarly, Sachin Bansal-owned Navi Technologies acquired Essel Group’s mutual fund business, renaming it Navi Mutual Fund.

These moves came at lightning speed after SEBI eased the regulations for new companies to set up mutual funds. Earlier, only profitable sponsors were allowed to set up mutual funds. The sponsor company is responsible for setting up and running the mutual fund.

However, as most financial technology (“fintech”) companies have been making losses since inception, they were barred from entering the mutual fund business.

In December, SEBI proposed a change to the regulations wherein loss-making companies were allowed to sponsor the mutual fund business, provided the sponsor companies met a minimum net worth requirement of Rs 100 crore.

For fintechs, SEBI’s decision opened up an entirely new area. So far, fintechs have been unable to monetise any of their businesses except merchant payments. The e-wallet business was made redundant by the United Payments Interface. The direct mutual fund selling business has no commissions. Currently, almost all fintechs are betting on their lending, insurance broking, and asset management businesses.

The current stock-market frenzy, combined with the fintech’s struggle to monetise their business, has culminated in the fintechs’ decision to enter the asset management business.

Investors To Benefit

With the rush into the mutual fund business, mutual fund investors are quite likely to see several benefits. Mutual funds have been lowering their expense ratios to attract more assets under management (AUM).

AUM refers to the total investor funds managed by the mutual funds. For instance, Navi Mutual Fund launched India’s cheapest index fund. It has an expense ratio of 0.06 per cent while other index funds with larger assets under management have expense ratios of 0.2 per cent or higher.

Some new entrants, like NJ Mutual Fund, Navi Mutual Fund, and Zerodha, are focusing solely on riding the passive investing tide. So far, several large actively managed mutual funds have continually disappointed investors. Passive funds rely on the efficient market hypothesis and track a basket of assets, relying on low costs and low turnover to deliver higher returns.

Consequently, passive funds have seen a worldwide rise in recent years. For instance, the $120 billion Fidelity Contrafund has seen $90 billion of net outflows despite outperforming the index. However, Fidelity’s passive funds have seen inflows of $120 billion during the same period. The index fund fees are almost a tenth of the Contrafund’s fees.

India has already seen a rise in passive investing, with the share of passive open-ended equity funds rising from 12 per cent in 2019 to 19 per cent in 2021. Other entrants, like Samco, are focusing on entering the actively managed mutual fund space.

Challenging Incumbents

The largest mutual funds have grown through their strong distribution networks. Smaller mutual funds did not have that, resulting in a small reach. But these fintechs have a strong penetration and have managed to on-board first-time investors. They have embedded themselves in people’s phones through their apps.

The strong penetration, lower fees, and ease of access would certainly help fintechs in challenging the incumbents.

Earlier, investors were less focused on the returns and more dependent on the mutual fund agent’s advice. But with the availability of data on the internet, investors have become more aware about the mutual fund ecosystem. They are unlikely to stick with underperforming funds for years.

Direct investing has also seen a substantial increase in recent years. The rise of direct investing is especially evident in the non-retail category. For one of India’s three largest AMCs, direct plans contributed to almost 50 per cent of the AUM, compared to 30 per cent of the AUM four years ago.

The rapid increase in direct investing signals that the incumbents’ distributor-led business models might not work as well in the current scenario.

AMCs Might Face The Heat

While consumers are likely to benefit from the increasing competition in the space, AMCs might witness a period of lower fees and profits.

In the United States of America, passive funds have seen their expense ratios dropping to near-zero levels. While large funds can survive on low ratios, smaller funds that lack scale are quite likely to struggle.

Recently, several mutual funds had to almost double the expense ratios of their index funds. The index funds had been struggling to pay their expenses and were sustaining on earnings from other funds. However, with rising competition, increasing expense ratios further would be quite difficult.

Even actively managed funds have faced fee pressures due to increasing competition in recent years. With no deadline on turning profitable, well-funded competitors might even burn money for a while, in order to attract investors, before focusing on becoming profitable.

Overall, the rapid increase in the number of players in the space would help lower the fees for investors and incentivise AMCs to perform better.

With an already established customer base, most of the companies entering the space have an inherent advantage. Yet, with increasing competition, especially in the passive investing space, AMCs might have to face revenue pressures until the market stabilises.

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