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June 26, 2005 10:36 pm

Mutual funds look at reaching the heart of India

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Sahara Mutual Fund, controlled by the flamboyant but now reclusive business baron Subrata Roy, this month became the latest Indian fund manager to showcase its products, joining other new entrants such as Fidelity, the world’s largest money manager, in India’s $37bn mutual fund industry.

Sahara’s entry comes as fund flows into equity and fixed-income schemes totalled Rs60bn ($1.4bn) in May, nearly double that of the previous month, following a recent slippage.

If that lifted fund managers’ spirits, they were soon deflated by an unusually severe public dressing down by Mr U K Sinha, the ministry of finance’s top official responsible for the financial services industry.

Speaking at a recent industry conference co-sponsored by Sahara, Mr Sinha said he was “most worried” about fund companies’ failure to expand beyond urban markets into rural India.

Rural India, where most Indians live, is often regarded as n untapped mass savings pool – a view supported by the fund industry regulator.

Mr Sinha contrasted modest flows into mutual funds last year, a net inflow of Rs22bn, with the huge demand by retail investors for public asset sales and initial public offerings. Last year more than 1m individual savers applied for shares in the IPOs by National Thermal Power Corporation, the largest generator, and Tata Consultancy Services, the biggest IT house.

“We just do not see this sort of response in mutual funds,” says Ashu Suyash, head of Fidelity in India. Traditionally, growth in Indian mutual funds has been driven by large investments from companies, which account for two-thirds of total assets under management.

But this could change, following the removal as part of India’s latest budget of incentives that allow companies to use mutual funds for tax arbitrage.

It does not help that companies are increasingly focusing on capital expenditure rather than financial investments, as India’s economy improves.

Mr Sinha said the onus was now on fund managers to reach out to the “vast potential of retail savers”. But the country’s 30 mutual funds – which include units of leading banks competing with global franchises such as Prudential – have barely scratched the surface of urban, let alone rural, India.

There are about 5m active mutual fund investors out of a potential investor pool of 250m salaried Indians. A further 3.75m investors have zero assets in their mutual fund accounts because of previous redemptions. This base of about 9m urban investors is the focus of the mutual fund industry and is the reason why rural, low-income Indians are largely neglected by an asset category that in mature markets such as Japan and the US is dominated by lower-income savers. 

“We are at least two years away from even looking beyond the 20 cities [with a population of at least 1m] plotted for our first phase of penetration,” says Mrs Suyash at Fidelity. 

Rajiv Bajaj, managing director of Bajaj Finance, one of India’s largest distributors of financial products, says mutual funds cover only 70 cities but “need to reach 200 to hit the industry target of Rs15,500bn of assets managed by 2015.”

Both mutual funds and stocks have only a 2 per cent share of investors’ overall asset allocation, compared with 10 per cent for gold, 20 per cent for bank deposits and 27 per cent for insurance and other government-backed savings.

The notion of a “vast untapped potential among small savers” has been reinforced by a recent ministry of finance survey of savings patterns in 17 Indian states, with respondents drawn from households with an income of Rs30,000 a month.

“Asked if they would invest in a scheme of no assured returns but that was well regulated, 20m people said ‘yes’. It shows there is much to tap, as well as demonstrating there is a great need for introspection in this industry,” Mr Sinha said.

While few in the industry dispute Mr Sinha’s argument, fund executives and sales agents believe the cost of establishing a national distribution is beyond most fund companies’ capacity.

Mr Bajaj, whose company runs a distribution network of 100 offices and 6,000 sub-brokers, says many fund companies lack the capital for a national roll-out. Distributors are also facing face puny margins, with some earning 2 per cent commission on sales of equity funds compared with 5-6 per cent in Singapore. “I have to sell multiple products to survive – mutual funds distribution alone is uneconomic,” Mr Bajaj says.

Fidelity has spent the past year mastering the art of selling funds to Indians who may be unfamiliar with such products but whose propensity to save is high.

“The trick is to do things simply, with a high focus on investor education and deep partnerships with distributors,” Mrs Suyash says. “We are doing in India what we did in Japan and the UK more than two decades ago.”

Fidelity’s cost in terms of time and money is exceptionally high because the fund must establish its brand, unknown in India, and educate clients familiar with only fixed-income and bank deposits.

Industry executives say a well-capitalised fund would have to invest Rs500m over five years to establish its franchise – a goal that is relatively easy to achieve because funds are usually aimed at urban investors who are financially literate. An expansion into small towns, however, would require much bigger investments.

“Our focus now is on the quality of communication of our core equity product. We are looking for sizeable market share over a 10-15 year time horizon,” Mrs Suyash says.

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