Should You Invest in Schemes of New Entrants in the Mutual Fund Industry?

September 13, 2021 Mutual Fund

The Rs 36.1 trillion Indian mutual fund industry seems all set to expand further with the entry of new players. India’s largest mutual fund distributor NJ India Invest and Stock broking firm Samco Securities have received SEBI’s approval to launch mutual fund business in India. Meanwhile, Zerodha, India’s largest stock broking firm, and Bajaj Finserv, one of the leading financial services companies in India have received in-principle approval to launch their mutual fund business.

Additionally, several Portfolio Management Services (PMS) firms such as Alchemy Capital Management, Helios Capital Management, and Unifi Capital are in the fray to join the mutual fund industry and are awaiting final nod from SEBI. Moreover, Fintech companies such as PayTM and PhonePe are also considering applying for the mutual fund license.

Why is there a sudden rush for mutual fund license?

The asset under management (AUM) of Indian mutual fund industry has more than doubled in the last five years. It has witnessed a 5-fold increase in the last 10 years. However, the growth has been restricted to a few large cities. According to a report by Jefferies, asset under management of Indian mutual fund industry is just 12% of India’s GDP, as against the global average of 63%.

The penetration in semi-urban and rural areas remains low. As a result, there is a huge scope of expansion in these geographies.

Transacting in mutual funds has become convenient due to the digital boom. New age financial services companies have further simplified the entire mutual fund investment process through their technology-driven approach. The ease of transacting online has attracted many investors, particularly millennials, towards mutual funds. Financial services firms, therefore, have ample scope to capitalise on their distribution network to grow their mutual fund business.

Another factor that has prompted new players to join asset management business is SEBI’s relaxation of eligibility criteria for sponsoring a mutual fund. It has allowed high net-worth companies as sponsors of mutual fund who do not meet the profitability criteria, but can enable wider reach to investors (for instance Fintech companies). With this, SEBI aims to facilitate innovation and enhanced reach to more investors at a faster pace.

Such companies will need to have a net worth of not less than Rs 100 crore for the purpose of contribution towards the net-worth of the Asset Management Company (AMC). This net worth of the AMC has to be maintained till the time the AMC makes profit for 5 consecutive years.

However, increasing awareness and financial literacy will be the key challenge for growth because investors in the cities beyond top 30 usually prefer non-market-linked and traditional products such as bank deposits, insurance products, pension funds, real estate, gold, etc.

Besides, the industry is dominated by top 10 players that account for around 82% of the industry’s assets. In other words, the remaining 32 fund houses account for just 18% of the total assets.

Therefore, with over 2,000 open-ended schemes from around 42 mutual fund houses, it remains to be seen how these new entrants stand out from the crowd, transform the business, and more importantly reward investors.

So, how are the new entrants planning to make inroads in the overcrowded mutual fund industry?

With the actively managed mutual fund space being over-crowded some new entrants plan to attract investors by providing good services at low cost through their technological capabilities. Zerodha has stated that it plans to focus only on passively managed schemes, whereas NJ India Invest will offer passive and rule-based (quantitative model-based) schemes.

Such schemes involve little or no intervention from the fund manager making it less prone to biases. Moreover, these schemes are less volatile compared to actively managed funds and entail lower costs.

On the other hand, Samco Securities will focus on actively managed schemes and aims to launch unique mutual fund products to differentiate them from the crowd.

Should you invest in schemes of new entrants in the mutual fund industry?

Investing in new fund offers is risky because it does not have a proven track record of performance and risk-reward matrix. This makes comparing and picking the right scheme within a particular category difficult. Remember that track record matters even when you invest in passively managed schemes. You need to assess factors such as expense ratio and tracking error before investing in passive schemes.

Moreover, there is no reliable track record of portfolio characteristics such as asset allocation, market cap bias, sectoral allocation, rating allocation (in case of debt mutual funds), portfolio churning, portfolio concentration, etc. that can help you to understand the risk involved.

Furthermore, when you invest in a scheme launched by a new entrant, it can be difficult to assess the investment philosophy and investment process that the fund house will follow. Remember, only process-driven fund houses that focus on quality and risk management can give you consistent performers over the long term.

[Read: How to Select Top Equity Mutual Funds for Your Portfolio]

If you do decide to invest in a scheme of a new fund house, you should check the investment mandate of the product being launched. You can consider adding schemes from new fund houses to your portfolio if they offer a unique proposition that is currently not available in the market and also if it can aid in diversification of your portfolio. The scheme should be suitable for your risk appetite and investment horizon and must enable you to realise your set financial goals.

Ensure that you review the performance of the mutual fund portfolio periodically. Some newly launched schemes perform well over the short term, but it is important to assess a scheme’s performance over the long term to determine its worthiness.

Ideally, if your existing portfolio is well-diversified to ride the market ups and downs you should stick to it instead of aimlessly adding new funds.

This article first appeared on PersonalFN here