Chapter 3 Mutual Funds in India since Liberalization

Transcription

1 Chapter 3 Mutual Funds in India since Liberalization 3.1 Introduction 3.2 Changing Economic Environment in India due to Liberalization 3.3 Evolution of Mutual Funds Industry in India 3.4 The Role of Association of Mutual Funds Industry (AMFI) 3.5 Regulatory and Legal Framework for Mutual Funds industry in India 3.6 Development of Mutual Fund Industry in India since Liberalization: Issues and Challenges 3.7 Role of Mutual Funds in House Hold Sector Saving Mobilization since Liberalization 3.8 Trends of Growth in Mutual Funds Industry 3.9 Unit holding pattern of Mutual Funds Industry 3.10 Mutual Funds vis- a- vis Banking Sector 3.11 Testing of Hypothesis

2 3.1 Introduction The previous chapter was a comprehensive description about the mutual funds. An elaborative description was made about the various types of mutual funds scheme, the advantage and disadvantages of investing in mutual funds were also discussed. The present chapter is devoted to study evolution of mutual funds industry in India, regulatory framework, issues and challenges of the Indian mutual funds industry, role of mutual funds in household sector savings, growth trend and the impact of liberalization on the overall growth and development of mutual funds industry in India. 3.2 Changing Economic Environment in India due to Liberalization There has been a radical transformation in India s economic environment since liberalization. The economic reforms in India were initiated to overcome the crisis resulting due to lack of foreign exchange reserves, lower credit ratings, suspension of foreign private capital flow and overall decline in industrial output 1. India was almost on the verge of defaulting foreign debt obligations. To overcome the crisis the government introduced various reforms. These structural reforms focused on liberalizing industry, trade, taxation and foreign investment, and on reforming the financial sector. The tariff structure was also reformed by the government making both export and import easier. These reforms were also aimed at removing impediments to growth, enhance transparency; improve market efficiency and self regulations 2. 80

3 Thu, as a result of financial sector reforms there has been an ease to entry barriers, participation of many private and foreign players in the mutual funds industry. Hence the Indian financial landscape has undergone significant changes. The financial institutions operating in the organized sector at present can be grouped into different categories as, represented in the figure 3.1. Figure 3.1 Financial System in India Financial assets - Deposits - Insurance policies - Pension Fund - Units Invest Through Financial Intermediaries - Bank/Insurance companies - Fin. Institutions - Mutual Funds -Financing Direct Investment Investors - Individuals - Business - Government Investment Cycle Invest In - Government - Business - Consumption Financial assets - Shares - Debentures - Units Invest Directly Financial Markets - Capital Markets - Secondar y Channelized Investment Source: Mutual Funds Emerging Issues in India, Excel Book,p.3 81

4 3.3 Evolution of Mutual Funds Industry in India The origin of mutual funds industry in India can be traced in the enactment of the Unit Trust of India (UTI) Act in According to Association of mutual funds industry in India (AMFI), the evolution of the industry can be broadly divided into four phases, which mark its transition from the period when UTI enjoyed the total monopoly in the mutual funds industry to a period of competition 3. Today there are three different types of players operating in the Indian Market UTI, non-uti public sector mutual funds and private sector mutual funds (including foreign mutual funds). As on March 2008, 37 mutual funds were in operation First Phase ( ) - Initiative taken by UTI The first phase began with the inception of unit trust of India (UTI). It was set up by Reserve Bank of India (RBI) and functioned under the Regulatory and Administrative Control of the RBI. UTI started its operation in July 1964 with a view to encouraging savings and investments and participation in the income, profits and gains accruing to the corporation from the acquisition, holding, management and disposal of securities 4. The first decade of UTI s operation ( ) was formative period. The first scheme launched by UTI was Unit-64. Another popular scheme launched by UTI was unit linked insurance plan (ULIP) launched in By the end of June 1974, there were six lakh unit holder and the investible funds was Rs. 172 crore 5. During the second phase (1974) UTI was delinked from RBI, openended growth funds were introduced. The number of units holder increased to 17 lakh and investible funds to Rs cr. by June,

5 The period from was the last phase of UTI monopoly. During this period many innovative products like Children s Gift Growth Fund (1986) and Master share (1987), were launched. The first Indian offshore fund, Indian Fund was launched in August By the end of June 1987, unit holding accounts amounted to Rs lakh and investible fund totaled over Rs. 4,563 crore 7. It still continues to be the largest player in the domestic mutual fund industry with an asset under management (AUM) of Rs crore having share 9.58% of the total asset under management on March 31, Second Phase ( ) - Enter Public Sector Mutual Funds This period was marked by the entry of non-uti public sector mutual fund, into the market, which brought in some degree of competition. The public sector banks, Life Insurance Corporation of India (LIC) and the General Insurance Corporation of India (GIC), which entered the market in 1987, set up these public sector mutual funds. These public sector banks were permitted to set up mutual fund after the amendment of the Banking Regulation Act, The first non- UTI mutual fund was of the SBI mutual fund established in June 1987, followed by Canara bank mutual fund in December 1987, Punjab National Bank mutual fund in August 1989, Indian Bank mutual fund in November 1989, Bank of India mutual fund in June 1990 and Bank of Baroda mutual fund in October LIC set up its mutual fund in June 1989 while GIC established its mutual fund in December During this period, the total assets of the industry grew to about Rs cr. with total number of schemes increasing to about 167 by the end of

6 3.3.3 Third Phase ( ) - Entry of Private Players This phase is marked by the entry of private sector funds, which posed serious competition to the existing public sector funds. Both domestic and foreign players entered the market, offering wide variety of schemes to investors. The first private sector mutual fund to launch a scheme was Madras-based Kothari Pioneer mutual fund. It launched openended Prima Fund in November The opening up of the market to private players saw international player like Morgan Stanly, Jardine Fleming, JP Morgan, George Roros and Capital International entering the market. With the entry of these mutual fund the number of mutual fund houses increased to 33 at the end of January, 2003 with total assets worth Rs. 1,21,805 crore Forth Phase (since February 2003) - Restructuring of UTI and Beyond This phase had bitter experience for UTI. The unit trust of India act, 1963 was repealed in Feb, 2003, leading to bifurcation of UTI into two separate entities. One is the specified undertaking of the unit trust of India with assets under management to the tune of Rs crore as at the end of January 2003, representing broadly the assets of US 64 schemes, and certain other schemes. The specified undertaking of UTI, functioning under an administrative and under the rules framed by the government of India and does not come under purview of mutual fund regulations. The second is the UTI mutual fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the mutual fund regulations. This was done in the wake of severe payment crisis that UTI suffered on account of its assured return scheme of US -64 that finally 84

7 resulted in an adverse impact on the Indian capital market. However the industry has overcome that shock. With mergers taking place among different private sector mutual funds and launch of innovative products, the mutual funds industry has entered its current phase of consolidation and growth. As at the end of March, 2008, there were 37 funds with average net asset under management of Rs cr. under 956 schemes 12. The table 3.1 depicts the major mile stone of mutual fund in India TABLE 3.1 Milestone of Indian Mutual Fund Industry India's first mutual fund, US 64 launched by Unit Trust of India. End of monopoly - UTI's stranglehold ends as the public sector banks join the mutual funds bandwagon Other financial institutions jump into the fray with the launch of LIC Mutual Fund. Threat of competition - The industry is thrown open to the private Sector. Kothari Pioneer Mutual fund sets a hot pace Foreign mutual funds arrive Mutual funds in troubled waters. CRB Mutual Funds closes shop 2000 Shakeout imminent UTI Crisis 2003 UTI Split up into UTI I and UTI II Source: Mutual Funds Data Interpretation and Analysis, Bharat publication From the above table it is evident that mutual funds industry in India has made significant progress since its inception in However the penetration of mutual funds in retail investor segment is poor which account for 10% of GDP as against 74% in the US 13. As mutual funds operations are largely concentrated in metros and big cities, it can be over 85

8 come by the active participation of retail investors, improving the middle class investor base and tapping the rural market. 3.4 The Role of Association of Mutual Funds Industry (AMFI) Association of mutual funds industry (AMFI) represents the AMCs in India. It was established as non-profit organisation on 22 August, It is dedicated to developing the Indian mutual fund industry on professional, healthy and ethical lines and to enhance and maintain standards in all areas with a view to protecting the interests of the mutual fund and their unit holders. AMFI's roles are broadly in four areas 15. Firstly, it carries out research and set standard for the industry. It tries to maintain international standard in the industry as mutual funds industry are global in nature. It makes comparative analysis of existing standard world wide and those prevailing in India. It recommends the best professional and ethical standards for the mutual fund companies in various areas like accounting, portfolio management, NAV construction, transparency, disclosure, communication, and evaluation and performance measurement of various funds. Besides recommending standard it ensures that the set standard is followed by the Indian mutual funds industry. Secondly, AMFI's has regular interaction with SEBI and both work in tandem to promote growth and development of the industry and develop best international practices for the industry. AMFI is officially the representative of the industry as it has an elaborative discussion with all the players of the industry before having any formal talk with SEBI regarding policy matters. Thus any policy pertaining to mutual funds is promulgated by SEBI only after having discussion with the AMFI. 86

9 Investor education is third important role of AMFI. This is done in association with FICCI, CII, ASSOCHAM and other bodies to ensure that investor have good knowledge about the market.as many investors are novice, they lack the know how of investment in mutual funds. AMFI try to cater to the need of these investors by conducting various seminars and conference to educate these investors. It also brings out monthly and quarterly updates for investors education. Beside this it also carries out research work and publishes it for the benefit of the investor. AMFI also has the responsibility to conduct the examination of intermediaries. AMFI has made it mandatory for all the intermediaries to pass the exam -AMFI Test, conducted both online (through NSE) and offline (through the UTI Institute of Capital Markets) and thereafter register with AMFI before they enter the market. The vision of AMFI is similar to that of investment company institute of USA (1989) 16, which is to advance the interest of investment companies and their shareholders, to promote public understanding of investment company business and to serve the public interest by encouraging adherence to high ethical standards by all elements of business. In order to achieve the above stated vision AMFI, as the open body has the following objectives 17 : To define and maintain high professional and ethical standards in all areas of operation of mutual fund industry To recommend and promote best business practices and code of conduct to be followed by members and others engaged in the activities of mutual fund and asset management including agencies 87

10 connected or involved in the field of capital markets and financial services. To interact with the Securities and Exchange Board of India (SEBI) and to represent to SEBI on all matters concerning the mutual fund industry. To represent to the Government, Reserve Bank of India and other bodies on all matters relating to the Mutual Fund Industry. To develop a cadre of well trained Agent distributors and to implement a programme of training and certification for all intermediaries and other engaged in the industry. To undertake nation wide investor awareness programme so as to promote proper understanding of the concept and working of mutual funds. To disseminate information on Mutual Fund Industry and to undertake studies and research directly and/or in association with other bodies. As mentioned above that AMFI was formed as non- profit organisation to fulfill the above stated objectives. It works under the control and guidelines of its board of directors. The promoter of AMFI can be identified by different categories as mentioned in Table

11 Table: 3.2 Promoters of Association of Mutual Funds in India Bank Sponsored SBI Fund Management Ltd BOB Asset Management Co. Ltd. Canbank Investment Management Services Ltd. UTI Asset Management Company Pvt. Ltd Institutions GIC Asset Management Co. Ltd. Jeevan Bima Sahayog Asset Management Co. Ltd. Indian Private Sector BenchMark Asset Management Co. Pvt. Ltd. Cholamandalam Asset Management Co. Ltd. Credit Capital Asset Management Co. Ltd. Escorts Asset Management Ltd. JM Financial Mutual Fund Kotak Mahindra Asset Management Co. Ltd. Reliance Capital Asset Management Ltd. Sahara Asset Management Co. Pvt. Ltd. Sundaram Asset Management Company Ltd. Tata Asset Management Private Ltd. Predominantly India Joint Ventures Birla Sun Life Asset Management Co. Ltd. DSP Merrill Lynch Fund Managers Limited HDFC Asset Management Company Ltd Predominantly Foreign Joint Ventures ABN AMRO Asset Management (I) Ltd. Alliance Capital Asset Management (India) Pvt. Ltd. Deutsche Asset Management (India) Pvt. Ltd. Fidelity Fund Management Private Limited Franklin Templeton Asset Mgmt. (India) Pvt. Ltd. HSBC Asset Management (India) Private Ltd. ING Investment Management (India) Pvt. Ltd Source: 89

12 Thus after having a comprehensive discussion on the role of AMFI, it can be said that its role has been pivotal in the growth and development of the Indian mutual funds industry. It has been working continuously on the development of best practices in all areas of mutual funds operation. It is actively associated with SEBI in matters relating to regulations and compliance, among others. Hence in many ways, AMFI as an association of mutual funds has played quite significant role. 3.5 Regulatory and Legal Framework for Mutual Funds industry in India We will now review the existing regulation of mutual funds and to suggest suitable measures that would make the mutual funds industry more accountable to the investors. As the present study focus on liberalization and structural changes that has been made in the Indian financial system in the post liberalization period. It is evident from the review of various literatures that significant outcome of these change in the financial sector is the development of new financial instruments. These new instruments were designed to meet the demands of investors, besides imparting a healthy competition in the financial sector. Mutual funds are one such financial instrument, which has proved catalytic for the growth and development of the Indian capital market. To keep the momentum going it is important that proper guide line is framed to facilitate its growth. Thus the regulatory framework must therefore, be designed to insure that the mutual funds are managed for the benefit of their investors. The mutual funds must not become instruments for benefiting the promoters or the government and the privileged (public sector) institutions. Another objective of the regulatory system should be 90

13 to ensure that mutual funds do not exploit their privileged position to gain an unfair advantage over individual investors who choose to manage their portfolio themselves 18. The very market structure of the industry also necessitates its own regulation. The chance of speculation has increased after the entry of private sector mutual funds. To overcome this, proper regulatory framework has to be evolved for overall growth and development of mutual funds industry. In pursuance of this, the Reserve bank of India issued the first set of guidelines, which were only applicable to the banking sector mutual funds, on July 7, The Ministry of Finance, Govt. of India issued guidelines on June 28, 1990 which required approval of mutual funds by Controller of Capital issues and their regulation with securities and exchange board of India (SEBI) 20. However the SEBIs role was minimal under these guidelines and it was only required to prescribe the accounting and disclosure requirements. Mutual funds faced the problems of compliance and monitoring due to the very existence of two set of guidelines. The SEBI (Mutual Fund) Regulations, which became operational on January 20, 1993, provided a formal regulatory framework for all mutual funds except the UTI 21. Also the money market mutual funds continued to be governed by the RBI. Mutual fund regulation underwent a major change by the SEBI (Mutual Fund) Regulations in 1993 and It was drafted in consultation with the fund industry participants. For this SEBI set up committees on accounting policies, net asset value and pricing for the mutual fund units. The involvements of mutual funds players in drafting of SEBI regulations strengthened their commitment to it and reflect the ground realities. Regulatory guidelines 91

14 were framed to overcome the problem relating to insider trading, late trading, switching assets, minimum number of investors for each schemes and marketing of mutual funds to protect small investors SEBI (Mutual Funds) Regulations 1996: An Overview In exercise of the powers conferred by the SEBI Act 1992, SEBI has issued the regulation for the mutual with the prior approval of the government of India. The important aspects of these regulations are discussed here separately from the fund point of view and form the investor s point of view Basic Guidelines for Mutual Funds The guidelines are applicable to all mutual funds that invest primarily in the capital market and partly in money market instruments. The Reserve Bank of India (RBI) regulates the money market mutual fund that invests solely in money market instruments. But SEBI regulates the money market scheme of added mutual funds. The Department of Economic Affairs, Ministry of Finance and the directives from RBI/Government manage the mutual funds that deal with offshore funds having the components of non-resident investors Establishment of a Mutual Fund To set up a mutual fund house, a sponsorship is required by a registered company with good track record in the form of a trust under the Indian Trusts Act. The trust is allowed to propose different schemes. Unlike the AMC, a trust is a different legal body. An AMC cannot act as the trustee nor is it allowed to carry out other business activities such as financial services consultancy, swapping of research and analysis, which 92

15 are not at par with the fund management activities. An independently established trust company will take care of trusteeship functions. If the trust is not formed, the existing debenture trustees, bank or financial institutions could act as mutual fund trustees. A minimum of 50% of the Board of Trustees would be autonomous members from outside and function independently from the sponsoring institution or its subsidiaries Rights and Obligations of Trustees As per the regulation 1996, trustees are made more responsible for the action of AMC. The following provisions highlight their responsibilities The trustees shall ensure that an asset management company has been diligent in empanelling the brokers, in monitoring securities transactions with brokers and avoiding undue concentration of business with any broker, Sec. 18(5). 2. The trustees shall ensure that AMC has not given any undue or unfair advantage to any associate, which may be detrimental to interest of the unit holders. (Sec. 18(6)). 3. The trustee shall ensure that the AMC has been managing mutual fund schemes independently of other activities and have taken adequate steps to ensures that the interest of investors of one scheme are not being compromised with those of any other scheme or for other activities of AMC (Sec. 18(8)). 4. Where the trustees have the reason to believe that the conduct of business of mutual funds is not in accordance with these regulations and the scheme they shall forthwith take such remedial steps as are 93

16 necessary by them and shall immediately inform the board of the violation and action taken by them (Sec. 18 (10)). 5. Each trustee shall file the details of his holding in securities on a half-yearly basis with the trust (Sec. 18(11)). 6. The trustees shall periodically review the investor complaint received and the redressal of the same by the asset management company. A minimum of 50 percent of board of trustee would be autonomous members from outside and minimum function independently from the sponsoring institution or its subsidiaries Schemes of Mutual funds The launch of different schemes depends upon the capital adequacy criteria of the AMC. In such cases, SEBI too would not withdraw the authorization. The prior approval of SEBI is required by all mutual funds to run their both closed and open-ended schemes. The fund houses would be needed to raise at least Rs. 20 crore for a close-ended scheme and Rs. 50 crore for open ended scheme. The close-ended schemes are not authorized to remain open for subscription for more than forty five days. For the open ended scheme, the initial forty five days of subscription period is taken into account for deciding the minimum size or corpus of the fund. It is mandatory that close end scheme be listed on a recognized stock exchange 23. However for open- end schemes the sell and buy- back could be done by mutual funds at a prearranged price Valuations Before the notification of the SEBI (Mutual Fund) Regulation, 1996, all the funds were using in-house valuation policies. As expected, the same 94

17 rates has since affected the performance of the funds with the debt funds giving a return of about 7.40% p.a. The leeway given to the fund houses for mark up/down needs to be reviewed. Some AMCs have already indicated the need for uniform valuation for illiquid debt securities Frequency of computation of NAV Net Asset Value (NAV) of the scheme shall be calculated and published in two daily newspapers at intervals of not exceeding one week 25. Earlier it was one month for open-ended scheme and three month for the close-ended schemes Pricing of Units In the case of open ended schemes the repurchase should not be lower than 93 percent of NAV and the resale price is not higher than the 107 percent of NAV. Further, the difference between the repurchase price and sale price of the unit shall not exceed 7% of the sale price Mutual Funds Investment Limitation The investments of mutual funds are permitted only in transferable securities that include money market and capital market instruments or securities debt. These holdings shall not exceed 10% with respect to growth funds and 40% in case of income funds. It is mandatory that the debt instruments are rated by approved credit rating agencies if this is not so then the approval of the board of AMC is required. Beside this mutual funds cannot invest more than 5% of their amount through any of their schemes in one single company or own more than 5% of any company's paid up capital containing voting rights. They are however permitted to invest more than 10% of their account in debentures, shares, 96

18 or additional securities of a sole company. But under no circumstances mutual funds are permitted to get involved in carry forward transactions and short selling 26. The Reserve Bank of India has now raised the overseas investment limit for mutual funds by $2 billion to $7 billion Money Market Mutual Funds In 1995, the RBI allowed private sector institutions to start Money Market Mutual Funds (MMMFs). They can invest in treasury bills, commercial paper, call and notice money, certificates of deposit and dated government securities, which will not expire up to a year. But with effect from March 7, 2000 RBI removed its guidelines on Money Market Mutual Funds. Thereafter, such Money Market Mutual Funds are absolutely managed by SEBI (Mutual Funds) Regulations, Disclosures The disclosure made by AMCs is very useful for investors in taking investment decision. All the AMCs maintain websites that are treasure troves of information about the AMCs, its trustees, directors, schemes, investment objectives, portfolio details, daily net asset values per unit and the performance of the schemes. For the more serious investor in the fund industry or for the fund researcher, all the information he may require for research is available. The archives are a ready source for the NAV history, the dividend declaration etc. The current guideline on portfolio disclosures makes it mandatory for the funds to disclose their top ten holdings in the portfolio on a monthly basis. The SEBI Mutual Fund Regulation 1996 mandate complete portfolio disclosure once in a quarter. Going beyond the regulatory 97

19 Investor Protection and Education Mutual funds in India are still to become popular avenues of investment, the reason being lack of awareness amongst the investor about the mutual funds 31. This is the reason for its poor customer base resulting into low rate of net resource mobilization by the mutual funds. To overcome this SEBI and AMFI are working together to educate the investors, and framing regulation to protect their interest. The advertising code to be adhered by the AMCs is one such example. The regulator takes any misleading advertisement by the AMC very seriously 32. It has also made it mandatory for the mutual fund advisor to undertake a certification course and be registered before he can act as advisor for the fund house. Guidelines on payment of brokerage to the fund distributors have also been tightened. These regulations will have a long-term impact on the functioning of the mutual funds. A well-informed investor will know the risks and the rewards before he invests his money and will be better prepared to accept the loss, should the value of his investment decline. It is in this backdrop, as a part of budgetary provisions that SEBI has decided to set up an Investor Protection and Education Fund (IPEF) 33. The market regulator SEBI and the AMFI have been working on nearly all regulatory aspects to make the mutual fund industry among the best regulated and most transparent industry in the financial sector. It has tried to bring out efficiency in the market and protect the interest of the investor. Efforts are being made that best international practices are adopted by the Indian mutual funds industry. All these have surely borne fruits as the number of players; number of schemes and the number of 99

20 investor has increased considerably. All this can be attributed to the efforts made by SEBI and AMFI. 3.6 Development of Mutual Fund Industry in India since Liberalization: Issues and Challenges It is now widely accepted fact that the Indian mutual funds industry has made enormous progress since liberalization. Investments in mutual fund have seen healthy growth in the last few years, especially with the entry of private investments mutual fund houses in India. The entry of private sector in 1993 opened a new era in the Indian mutual fund industry which has matured in terms of assets under management (AUM), number of assets management companies (AMCs), number and variety of products and the participation level in the Indian capital market. In spite all great progress there are certain important issues and challenges relating to the Indian Mutual funds Industry which need to be addressed at the earliest for the growth and development of Indian Mutual funds Industry. It can be observed from table 3.3 that in India the asset under management is 10% of GDP that is quite low compared to to 74% in US 100% percent in Australia and 45% in Brazil 34. Table: 3.3 MF AUM as % of GDP Hong Kong 271% Source: Religare Securities,2007 Australia 100% US 74% Brazil 45% Korea 35% UK 23% India 10% 100

21 Figure 3.2 MF AUM as % of GDP Source: Religare Securities, 2007 Besides low share in GDP in terms of percentage, the participation of retail investor is also low compared to that of US, where the retail investor participation is 87% whereas in India it is only 42%.As larger share of savings in India are still parked in banks and other government securities. The investment in mutual funds is only 14% of total bank deposits and account for 11% percent of combined market capitalization of BSE and NSE indices. 35 The reason behind the low rate of growth in AUM in India as compared to some other countries is the concentration of customer base in metros, big cities and Class 1 towns that together constitute around 77% of total investors base 36. A large part of the Indian economy has not been tapped yet and there has been lack of penetration by the MFs in the rural and semi-urban areas 37.This need to be immediately looked into and addressed as the future growth and development depends to a large extent on increasing investor base. Once this issue is taken care of by the industry than automatically the share of net assets will go up and the gap between saving and investment will narrow down. 101

22 3.6.1 Ratings of Mutual Funds Schemes The ratings of fixed income securities and money market instruments are in practice in India. The ratings of mutual funds are restricted greatly to debt funds and ratings methodology is further to credit quality assessment (CQA). CQA is purely quantitative exercise in which historical default and transaction rates are combined with the weightage of the portfolio in each category to arrive at number score 38. On the basis of this score final rating is done. The rating of mutual funds scheme in India is done by the Credit Information and Services of India limited(crisil),which has developed composite performance ranking which measure the performance for each of the schemes.the criteria of ranking include two-year net asset value(nav) history and 100% portfolio disclosure Issues of NPA Classification To provide guidelines for the classification of NPA, Malegan committee was constituted. The committee has made important recommendations regarding norms on classification of NPAs in debt securities and norms for valuation of liquid securities in a mutual funds schemes. The committee has recommended that if principal sum is not received for six month, than the debt security can be classified as nonperforming assets (NPA) The Issue of Fluctuating Returns In spite of being a diversified investment solution, mutual funds investment in no way guarantees any return. If the market prices of major shares and bonds fall, then the value of mutual fund shares are sure to go 102

23 down, no matter how diversified the mutual fund portfolio be. It can be said that mutual fund investment is somewhat lower risky than direct investment in stocks. But, every time a person invests in mutual fund, he unavoidably carries the risk of losing money Other Important Issues related to Indian Mutual Funds Industry The mutual funds industry in India does not have market accessibility to semi urban and rural areas. The investor participating in the mutual funds have little knowledge about the financial products. Educating investors about the mechanisms of the working of mutual funds and its return associated with the market. Introducing innovations in product design to suit everyone like having life-cycle products such as pension for protection as well as source of returns aligned with market movements and improving marketing strategy to boost growth and development of the industry Challenges for the Indian Mutual Funds Industry Lack of awareness and a risk aversion among retail investors are the major challenges for the industry. Educating investors about the advantages of investing in mutual funds compared to risk-free saving instrument is a big task for the industry. According to the Securities Market Infrastructure-Leveraging Expert (SMILE) 40, the transaction cost of establishing collection centers, delay in fund transfer and tardy intercity payment system are the major impediments. So, enhancing the reach through the existing distribution model will require more investments. As of now, mutual fund investments are confined to the metros, tier 1 and tier 2 cities (about 50 cities) 41. A major reason for this is the high cost 103

24 of developing retail infrastructure. So, scaling up the operation by increasing the volumes through increasing investment in other cities doesn't seem feasible. The extensive availability of the Central Government's assured return on small savings products are restricting the competition as well as the penetration of a wide variety of mutual fund products, particularly in the smaller towns, where investors are not willing to take risk. This poses a great challenge for the industry to realize its potential Curbing Unethical Practices Mutual funds industry is facing the challenge of controlling undesirable practices. This is mainly due to efforts put up by different AMCs to woe the distributor who in turn in order to increase the sale of particular products often misguide investor about any products like projecting the return of any scheme beyond the normal return.this seriously affects the faith of any investor and dissuade him from investing in mutual funds. However, the client's concern and his needs should be of prime importance while selling. To curb such unethical practices, the Association of Mutual Funds in India (AMFI) has prescribed that the agents/distributors must have AMFI certification Spreading the Mutual Fund Culture Though the Indian mutual fund industry has a huge market potential, it is yet to be realized. To realize its growth potential, the industry will have to focus on its reach in the retail segment. According to A.P Kurian, Chairman, AMFI, there are about 180 million households in India, of which only 11.8 million invest in mutual funds, making it a 104

25 penetration of 6.7%. In urban areas, 13.7% of the households invest in mutual funds; in rural areas this percentage is just 3.8%. So, there is a need to focus on rural penetration for future growth. In India it is estimated that 6.7% of the households hold mutual funds 42. This figure is close to 50% in case of the US and 17% in case of UK. Mutual funds account for about 0.73% of total financial assets in India and 11% of bank deposits. AUM for Mutual funds had exceeded the bank deposits in US in as early as To achieve mutual funds growth, educating the customers about mutual funds as a savings vehicle will be critical. More efforts are required from the regulators and the industry to manage the wealth of individuals to further propel the growth of the industry by popularizing the use of mutual funds. The government should properly regulate and monitor the regulation so that a favorable climate can be created. Regulations should be tightened to curb unethical practices. They should also develop a comprehensive risk management system so that it can induce more investment. The industry should focus on product innovation and maintain transparency, flexibility, service and innovation to realize its potential Transparency The issue of transparency is another major challenge for the mutual fund industry in India. There is certain information which is not passed to the investor. One such important information is the construction of portfolio of particular schemes; in this regard SEBI has made it mandatory for MFs to disclose the portfolios of all schemes every six months. Taking 105

26 cue from this some mutual funds has begun making monthly disclosures 43. SEBI has also taken various steps to empower the investors in mutual funds by way of more transparency in the loads borne by the investor so that the investor can take informed investment decisions and there is more transparency in payment of commission to mutual fund distributors 44. Also the literature on each scheme contains information about net asset value (NAV) and dividend payouts which most ordinary investors do not comprehend as the explanations are not exactly in the simplest language 45. In this backdrop, it is imperative for investors to understand that it is always better to invest in a fund with a successful track record of not only in terms of quantitative performance, but also in terms of maintaining the fund management philosophy to achieve the objective it originally set out for. To conclude, educating investors will definitely do well both to the mutual funds as well as the investors in the long-run. That will truly be mutual Curbing irregularities The mutual funds industry is often faced with irregularities which may pertain to either insider trading and often fund manager obtains information about specific stocks and influence its purchase and sale price. To avoid and prevent such unethical practices, SEBI has issued regulations that trustees furnish a certificate to it stating that they have satisfied themselves and that there have been no instances of insider trading by any of the trustees, directors or key personnel of the asset management companies. 46 The compliance officer is also required to keep track of the 106

27 transactions of the mutual fund employees and the mutual fund so as to ensure that there are no conflicts of interest even if the mutual fund has transacted the same securities before or after the employee's transactions. Employees have to furnish the declaration of transactions and monthly statement of holdings ensuring that no insider trading has happened Protecting the interest of retail investors Mutual funds were started with the objective of giving the retail investor an opportunity to invest in stock market. However they are now presently dominated by the institutional investors who have large share in the assets under management. Hence, this poses a major challenge before the industry to attract small investors. To achieve this objective of serving small retail investors, SEBI plans to restrain the trend of AMCs launching schemes catering to corporate and institutional investors. Further the retail investor should be encouraged to invest in stock market through mutual funds. Once the mutual funds truly start representing the small investors, 50 per cent of any IPO must be reserved for it, which effectively would be in favor of the retail investors. This can be adopted as a means to augmenting the share of the retail investor in mutual funds. C. B. Bhave, the chairman of SEBI, too emphasized the importance of non-corporate investors. He said it is in the interest of the industry to have increased investor participation, particularly from individuals as they imparted stability to a mutual fund 47. Hence by protecting the interest of the retail investor and providing them necessary safe guards the Indian mutual funds can achieve high growth and development. 107

28 Minimizing High Operational Cost High operational cost and slow expansion of distribution net work is another major challenge for the Indian Mutual funds industry. This was revealed by the combined study conducted by Confederation of Indian Industry (CII) and Price Waterhouse Coopers (PWC) 48, lease rentals and staff costs contribute to the bulk of operational costs. The industry therefore should try to overcome this and bring efficiency in operation by adopting better technology and trained manpower. 3.7 Role of Mutual Funds in House Hold Sector Saving Mobilization since Liberalization Savings is the difference between Income and Expenditure. Savings helps the economy to progress on a continuous growth path as Investment is financed internally out of savings. This reduces dependence on external sources for financing our infrastructural and other needs thus bringing out stability in economy and growth process. The present study is an endeavor to trace the contribution of mutual funds in mobilizing house hold sector savings in India. The study also tries to find out to what extent liberalization has been successful in mobilizing savings and its growth rate. Financial reform typically comprises several key phases that are often separated by several years. Reform measures are introduced in a number of different dimensions: interest rates, credit allocation, bank ownership, prudential regulation, security markets, and openness of the capital account

29 Savings is primarily determined by various factors which include income, policy- reforms, interest rate, tax incentive and other measures adopted to facilitate savings 50. The household sector savings which is comprised of the pure households, non corporate enterprises in agriculture, trade and industry and private non profit making trusts. Its growth is determined by the factors as discussed below Income Gross Domestic Savings in India has shown a steady and substantial rise from the 1950s along with the rise in income (GDP). People with extra income park their money in various avenues of financial savings 51. Mutual funds offer the best bet for investment as the money invested in mutual funds are professionally managed, well diversified, thus reducing risk and optimizing return Impact of Liberalization on the growth of saving rate Economic liberalization measures initiated in 1991 has contributed to GDP growth rate (average growth rate 5.6%) and the savings rate (17%).Thus during the period the saving rate has shown continuous growth, as savings rate percentage of GDP was 29.8, 31.7, 34.2, 35.7, 37.7% respectively during the period to implying that liberalization measure adopted to boost the ailing economy has bear fruits both in terms of improvement in the rate of savings and increase in GDP 52. It has also enabled India to have sound balance of payment position and reserve of foreign exchange. 109

30 3.7.3 Interest Rates Financial liberalization initiated in 1991 introduced remarkable changes in the financial system, it restructured the existing interest rate to make them more rational and market oriented. Presently, all interest rates, except those on all small savings schemes of Post Office, Provident funds, Government of India Bonds and schemes for Senior Citizens (the instruments with sovereign guarantee), are market determined. In post 1991 period there has been a steady decline in the interest rates in the economy 53. But overall household savings increased from 17% of GDP in the 1980s to 37.7% of GDP in The transformation from an inefficient and protected economy to an efficient and a market determined economy have made people more insecure and prompted them to accumulate savings to guard against future job losses, giving limited importance to interest rates. The insecurity prompted to increase the savings rate. Another fact considered by retired people who were pensioners was that since interest rates had gone down to maintain the same income flow they had increased the volume of savings, to the extent possible. So it can be concluded that interest rates do not influence savings much Tax Incentives Tax incentive is another measure adopted by the government to promote savings 54. Thus people in large invest in such avenues to have double benefits of capital appreciation and tax incentives. Mutual funds too have launched various schemes investment in which gives people tax incentives. 110

31 3.7.5 Contribution of Household Sector Savings in Mutual Funds The role of house hold sector saving in the growth and development of the capital market is important. To augment the share of house hold sector saving various initiative were under taken by the government but it seems that all these has failed to yield desired results. This is evident from the fact that the share of financial savings of the household sector in securities (shares, debentures, public sector bonds and units of UTI and other mutual funds and government securities) has come down from 22.9% in to 10.5%in ) 55. This is reinforced by the survey conducted by the SEBI-NCAER, which found that only 2.8% of investment of all households were in securities (1.4% in equity shares, 1.3% in mutual funds and 0.4% in debentures), while the remaining 97% in non-securities, indicating low priority of investor for securities. Despite the development of the securities market, a very small percentage of households savings is channelized into the securities market. This trend indicates lack of interest of investors in the security market. Though there was a major shift in the saving pattern of the household sector from physical assets to financial assets and within financial assets, from bank deposits to securities, the trend got reversed in the recent past. This is due to high real interest rates, prolonged subdued conditions in the secondary market, lack of confidence by the issuers in the success of issue process as well as confidence by the existing investors in the securities market. The poor performance by mutual funds is another factor which is keeping investors away from mutual funds investment. The lack of awareness about securities market and absence of a dependable infrastructure and distribution network coupled with aversion 111

32 to risk inhibited non-investor households from investing in the securities market. This means that by and large percentage of household sector saving is still channelized into safer avenues of investment like bank deposits, post office deposits etc. This is true for mutual fund also as its proportion of savings in total financial saving of the household sector has declined since 1991 as shown in the table below: Table: 3.4 Proportion of MF in Financial Saving of the Household Sector (Gross) Year UTI Non- UTI Total Source: Compiled from various years annual reports of RBI 112

33 From the above table it is evident that share of mutual funds savings in total financial savings of the house hold sector has declined over the years. It was 9.1 percent of total financial savings in 19991, less than 1 percent in , turning negative in and , which is mainly due to UTI scandal in 2001 and consequent splitting of UTI into UTI I and UTI II in This made huge out flow of money from UTI and shook investor s confidence in mutual funds. However the year proved comparatively better for the mutual funds industry primarily due to the better performance of the security market. It is also evident from the table that the share of UTI mutual funds has decreased gradually over the years and its share is almost negligible in total financial savings of the house hold sector in It is observed from the above table that the share of mutual funds in total financial saving of the house hold sector has declined over the years.this means that mutual fund as vehicle for mobilization of financial savings can be employed to increase the rate of house hold sector savings. This can be achieved only after proper education of the investors about the mutual funds. 3.8 Trends of Growth in Mutual Funds Industry Mutual funds, industry have made impressive growth since liberalization. The growth has been in terms of their number, unit capital, investible funds, number of investors and number of schemes etc. The table 3.5 depicts the present scenario of Mutual Funds in India. 113

34 Table 3.5 Current Status of India Mutual Funds Industry Number of Players 37 Number of schemes 956 Open end schemes 592 Close end scheme 364 Average net asset under management Crore. No. of Individual Investors 4.20 Crore Source: Amfiindia.com and hand book of SEBI The Mutual funds industry has grown enormously over the last four decades. Since its inception with Unit Trusts of India (UTI) in 1964, offering a single scheme unit 64. Now there are thirty seven players in the Indian mutual funds industry offering nine hundred fifty six schemes as shown in the table 3.5 above. The table 3.5 also reveals the average net asset under management of the mutual funds industry is Rs Crore which is nearly times the asset under management in The composition of schemes has also changed during the period keeping in mind the various needs of the people. Thus, it is evident from table 3.5, that there has been over all growth in all spheres in the mutual funds industry. Since, the liberalization the Indian mutual funds industry has undergone changes to keep pace with the new demands offered by the market. One such change is the introduction of mutual funds regulation in It was in this year that private and foreign mutual funds started participating in the industry 57. Today the industry consists of the Unit Trust of India, mutual funds sponsored by public sector banks and 114