Mutual Funds, Role of

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MUTUAL FUNDS, ROLE OF

MUTUAL FUNDS, ROLE OF The foundation for the mutual fund industry in India was laid in 1963 with the passage of the Unit Trust of India (UTI) Act. The act entrusted the Reserve Bank of India (RBI) with the task of setting up an institution that could facilitate the mobilization of resources from investors across the country. The UTI then floated its maiden open-ended fund in 1964, Unit-Scheme 1964, popularly known as "US-64"; the UTI Act had provided for an initial capital of 50 million rupees to be invested in this first plan. Several insurance companies, finance institutions, and banks, including the RBI, contributed to this initial corpus.

The initial years of the UTI Act laid down the milestones of policies, standards of conduct and practices, and processes of management. The Board of Trustees initially decided to offer the sale of units at a nominal value of 10 rupees each at par for the entire month of July 1964, attracting of 175 million rupees from 125,000 investors. US-64 underwent many changes, with added features, including a reinvestment plan, under which the unit holders automatically reinvested dividend earnings, and a children's gift plan.

During the initial years of development, from 1964 to 1987, UTI was the lone mutual fund, managing five open-ended funds. The second phase started in 1987 with the arrival of new mutual funds, sponsored by nationalized banks and other public sector financial institutions. The State Bank of India (SBI) and Canara Bank set up an SBI Mutual Fund (SBI MF) and Canbank Mutual Fund (Canbank MF), respectively, in 1987. Subsequently, other public sector banks and insurance companies joined the race by the end of 1990. With the beginning of economic liberalization, the financial sector industry also witnessed liberalization, with new players, new regulations, and a new structure. In 1993 the Securities and Exchange Board of India (SEBI), the capital market regulator, for the first time issued mutual fund regulations, which permitted entry to private sector mutual funds.

The UTI Act of 1963 was repealed in February 2003, and consequently UTI bifurcated into two distinct organizations: Specified Undertaking of Unit Trust of India (popularly known as UTI I) and UTI Asset Management Company Limited (UTI AMC). The UTI I is under the supervision of the government of India, and UTI AMC is regulated by SEBI.

The first growth fund (mutual fund), Mastershare, was launched in 1986 by the UTI. The success of Mastershare provided impetus to float more growth-oriented funds. Consequently, new entrants to the industry, namely Canbank MF and SBI MF, joined the race. The year 1989 witnessed further product innovations: venture capital funds began operating for the first time, and tax saving funds also entered the market. SBI MF was the first to offer a tax saving fund, while UTI offered a venture capital fund. Assured return funds started functioning from 1990 with the launch of Candouble. With a view to meeting the objectives of different sectors, the industry has responded by introducing products such as regular income, capital appreciation, and a children's gift growth fund. The industry is in the process of introducing more new products, including a commodity mutual fund and a real estate mutual fund.

Growth and Status

By June 1974, investable funds under UTI's management reached 1,720 million rupees (unit capital 1,520 million rupees). There were 6 lakh (600,000 rupees) unit holding accounts under four plans. US-64 investors were rewarded well, with their investment consistently earning better returns than deposits in banks. It was during the 1980s that UTI grew in stature to emerge as one of India's large nationwide financial institutions. From 1981 to 1984, UTI introduced more than six new open-end and closed-end schemes; investable funds quadrupled from 5 billion rupees to 20 billion rupees; the number of unit holding accounts grew from 1 million to 1.7 million; and the number of branch offices increased to eleven. From 1986 to 1990, UTI launched a large number of innovative products, strengthened the marketing network, and promoted new organizations in the financial sector.

The industry has, however, experienced a sporadic expansion of late. The assets under management slowly grew from 32,180 million rupees in 1985–1986 to 1,396,160 million rupees in 2003–2004. The yearly resources mobilized also have had ups and downs. In the year 2003–2004, the industry mobilized 468,090 million rupees, the highest in its history. As of 31 March 2004 there were 403 different plans.

Consolidation in the Indian Mutual Fund Industry

India's mutual fund industry, under its new regulatory environment, is quite young. There was an initial exuberance, and many domestic as well as overseas professional and industrial houses sought regulatory licenses to set up asset management companies to manage mutual funds. Many of them have been granted licenses. A large number of mutual fund houses have been set up. Some mutual fund houses could not attain a critical mass for many years, and several foreign funds found it very expensive to operate in India.

Competition in the industry increased pressure on marketing expenses, and the relatively small investor base made it difficult for smaller players to survive. For all these reasons, consolidation of the Indian mutual fund industry began, and since 2000 some of the industrial houses have sold their assets to other mutual funds.

Challenges

Though the industry started with one lone player, in 1986 the government of India allowed others to enter, and now many public, private, joint, and foreign sector mutual fund houses operate in India. Yet the growth of the industry has not been very impressive. Unlike most countries, in which retail and small investors are the major investors in mutual funds, in India the share of retail investors has recently been coming down. Corporations and institutions accounted for about 57 percent of total investors as of 31 March 2003, and individuals accounted for only about 41 percent.

Close examination of the investment pattern of Indian mutual funds reveals that there is a heavy tilt toward fixed income products (government debt, money market instruments, and corporate debt). Mutual fund industry champions need to initiate mass level investor education about the mutual fund industry and its pros and cons. Many investors still believe that investments in mutual funds cannot give negative returns.

Frequent change in tax policy has caused aberrations in the functioning and performance of the funds. Incentives are extended, withdrawn, and reintroduced many times, without sufficient notice, causing disturbances to the industry in its assets and performance. The industry, after a long period of existence, is still confined to large cities and towns. Most investable funds come from urban areas. In order to grow and serve larger economic functions, the industry must spread its scope to other areas.

A very skewed interest rate environment exists in India. There are certain guaranteed return plans of the government of India that offer higher rates of fixed coupons, some of which provide tax breaks. For certain categories of investors, the effective rate of return is very high over time. Therefore, among small investors in semiurban and rural areas, there is a lack of interest in mutual funds. This is a major hurdle that has inhibited the development of a more vital mutual fund industry.

M. T. Raju