The upstarts disrupting mutual funds industry P10 REPORTAGE TALKING POINTS IDEAS INSIGHT THE BOTTOMLINE THE UPSTARTS DISRUPTING MF INDUSTRY A string of new entrants want to radically rejig the world of mutual funds. Will they succeed? From left to right: Nithin Kamath, founder and chief executive officer of Zerodha Group; Sachin Bansal, founder of Navi AMC; Deepak Shenoy, founder and chief executive officer of Capital Mind; and Aashish Somaiyaa, chief executive officer of White Oak Capital Neil Borate email@example.com MUMBAI nearly September, Flipkart co-founder and former chairman Sachin Bansal played a masterstroke in the mutual fund space. A regulatory filing by his group's mutual fund businessNavi Asset Management Companyshowed that it would soon bring Vanguard's funds to Indian investors. Founded by legendary investor John C. Bogle, Vanguard is apassive investing behemoth with a huge fan following all around the world and Bansal was set to bring its products to India. Navi'spush for Vanguard isjust the latest in aseries of nascent yet highly disruptive movestorock India's usually conservative and stable mutual fund industry, which has until now been dominated by a few large bank-owned asset managers. The winds of change started to blow in December 2020, when anew circular from the market regulator Securities and Exchange Board of India (Sebi) allowed fintechs to launch their own mutual fund productseven ifthey weren't profitable. Sebi, however, mandated that such newage asset management companies (AMCs) should have a net worth of at least KIOO crore (up from the 50 crore that is currently needed for a regular AMC). This newly codified minimum net worth must be maintained until the new AMC turns a profit for at least five consecutive years. Following the Sebi circular, an industry which was already witmessing heightened interest from fintechssaw a mini explosion ofnew entrants or wannabe entrants who are waiting in line for alicense to operate. Prominent upstarts who have received a brand-new license in recent months are discount brokerage Zerodha, Prashant Khemka's White Oak Capital, Bansal's Navi Mutual Fund and NJ Mutual Fund, which is owned by the eponymous MF distribution company. Other prominent individuals who are waiting in the wings are Deepak Shenoy of Capital Mind, noted investor Rakesh Stringent conditions within the MF space have meant that very few licenses were issued each year and incumbents "We have treated India as one uniform market and painted all (the) investors in India with the same brush. A lot ofinnovation is waiting to happen," said Saurabh Jain,managing directorand chiefexecutive officer, Navi Mutual Fund. "A mutual fund portfolioshould be like a subway sandwich. Youchoose your own topping and sauces according to your risk appetite and goals. The products that we have filed for sO far are reflective of that (philosophy)," he added. Similarto the banking sector, the realm of mutual funds has been a tightly regulated business in India. Stringent conditions meant that very few licenses were issued each year and incumbents usually enjoyed extraordinary profits merely by existing. "(Until now, AMCs would launch the same set of products under different names. There wasno attempt to think outside the box," said Deepak Shenoy, founder and chief executive officer, Capital Mind, which has applied for a mutual fund license. "The old established players (have) leveraged their associated banks in order to grow assetsand are wedded to that labour intensive model. But now, you can reach investors online through technology directly. You donot needa vast army of dis~ tributors or relationship managers," Shenoy added. Whatremains tobe seen is whether all of this is merely big talk or will the ground beneath India's growing club of investors indeed shift towards a positive, COnSumerfriendly direction in the near future. SHADOW ON ACTIVE FUNDS S &P Dow Jones Indices issues a report each year documenting the performance of actively managed mutual fundsin India. According tothe SPIVA Report, for the first half of 2021 (ending in June 2021), market indices beat 86% oflarge cap funds, 57%of mid-/small-cap and 54% of equity-linked savings scheme or ELSS funds. Over a 5-year period, the figures are rather similar at 83%, 70% and Jhunjhunwala and usually enjoyed extraordinary 76%, respectively. Helios Capital founder . . Despite questions about Samir Arora. profits merely by existing the effectiveness of Passive investing actively managed funds, (tracking an index instead of actively picking particularstocks) isa key element of the newcomers' strategy. A focus on international funds and bringing down expense ratiosare other cogs. Several other cards up their sleeves are yet to be revealed. One thing iscertain though: the blas world of mutual funds isin for some big shifts. themutual fund investor base in India has largely ignored the data. Part ofthe reason for the collective shrug is the ecosystem through which the mutual fund industry operates. AMCspaid commissions to distributors, who, in turn, serviced investors. Commissions were far higher in the actively man aged fund category than in index funds or exchange-traded funds (ETFS). It wasin no one's interest to reduce the cost and commissions associated with fund management. Howeverin 2015, the Employees' Provident Fund Organisation (EPFO) announced that it would be investing 10% ofitsincremental collectionsin ETFs. This was subsequently raised to15%. The EPFO decision added heft toa hitherto marginal segment of the mutual fund industry and offered the benefits of scale to mutual funds who did want to focus on the segment. Meanwhile, another revolution was brewingthat challenged the ecosystem of 'regular' or commission-bearing mutual funds that are distributed largely by big banks. This was the rise of fintechs registered as investment advisors (popularly known as RIAs). These fintechs offered investors the ability to invest in direct (commission-free) plans of mutual funds without any extra charges and spent a considerable part of their marketing budgets highlighting the effects of commissions and cost on the returns that investors got. As a result of these shifts, the share of passive mutual funds had already started rising steadily from1.1% of the total AUM in January 2015 to10%in August 2021 BHARAT BOND EXPERIMENT In December 2019, Radhika Gupta, chief executive officer of Edelweiss Mutual Fund and one of the industry's largest social media influencers, was engaged in a frenzy of activity. Her small AMC, Edelweiss Asset Management Company, had received amandate from the government to manage India's first passive debt mutual fund. Conventional wisdom until then insisted that while passive investing could work in large liquid equity markets, debt needed thesteadying hand ofa fund manager. The lack ofliquidity would mean mutual funds at times won't be able to meet large redemptions. However, withinamonth or so, Gupta's team had pulled off the unthinkable. The first set of Bharat Bond ETFs were born and had collected over 12,000crore. Passive investing had come to debt mutual funds. The Bharat Bond launch was followed by aseriesofcopycat products from the rest of the industry. The success alsothrew open the doorto product innovation, astrategy thatthenew entrantsare banking on now. "With the shake-up of the industry that is now underway, L expect alot more products to emerge," said Capital Mind's Shenoy. "The recent permission toset up Silver ETFsis acase inpoint. We can have ETFstracking several other commodities." WHAT The blas world of mutual funds is in for some big shifts. Many prominent upstarts have received licenses in recent months. The list includes Zerodha and Navi Mutual Fund. AND The newcomers have several cards up their sleeves such as passive investing. A focus on international funds and bringing down expense ratios are the other cogs. BUT What remains to be seen is whether all of this is merely big talk or will the ground beneath India's growing club of investors indeed shift towards a positive, consumer-friendly direction. Even as the new entrants shake-up an entrenched ecosystem, the industry itself has been affected by a Sebi initiative launched in May 2021 to set up a centralized platform to buy and sell mutual funds. The platform called MF Central would also handle service requests. Itwould be funded and run by registrar and transfer agents (RTAs)and potentially threatens the business of India's vast army of distributors, who are an integral part of the traditional MF ecosystem. MF Central can also level the playing field between established and new AMCs, reducing the need to set up extensive cUstomer service and operationsteams. "With initiatives like MF Central, costs will fall acrossthe board on routine services issues like nomination and transmission and this can level the playing field between the incumbents, who already have large service capabilities, and the new entrants," said Dhirendra Kumar, chiefexecutive officer, Value Research, a mutual fund data and analytics portal. However, Kumar, is a sceptic and does not believe that a big shift is underway, "1 do not think that the new fintech players will take away a significant market share fromthe incumbents or spark aracetothe bottom in terms of fees and expenses. Brokers, distributors and fintechs have all applied for a mutual fund license in large numbers. Entity/Group Main group G business NAVI MUTUAL FUND Acquired Essel Mutual Fund Loans NJ GROUP ' MF License granted distribution BAJAJ FINSERV Loans, License granted credit cards GROWW Direct Acquisition of Indiabulls MF MFs WIZEMARKETS ANALYTICS Applied PMS ALCHEMY CAPITAL PMS Applied PMS: Portfolio management services The growth of the passive fund category has been brisk over the last 3-4 years. 10 / Passive share of i ,10. 8 industry AUM (in %) & 6 & 4 , K 0 Jan 2015 Aug 2021 Approximate share including gold exchange-traded funds. Source: The Association of Mutual Funds in India, Mint Research Brandsstillhold alotof power in India and some ofthe existing players have powerful brands. Rather,thenew entrants are likely to expand the market and bring in small investors who are not currently well serviced by the distribution ecosystem," he said. THE EMERGING CHALLENGES Cyrilanth Meenakshi, founder, Priminvestor.in, is also cautious about the extent to which the current industry playerscan be challenged. "It is not easy to create competitive advantage in the mutual fund industry on product or strategy. When one fund house launches a successful model, it quickly gets replicated. Take the PPFASPFlexicap model of partially investing in US stocks. Several other fund houses are also doing it. Similarly, take the Motilal NASDAQ ETF. Several fund houses have launched their own Versions." It is true that the surge of new players couldspur innovation, akin to what ensued after the launch of the Bharat Bond ETF, Some industry players don't believe that the new fintech players will take away a significant market share from the incumbents; brands still matter in India Meenakshi said. "But the room for this is limited because these strategies are easily replicated. Alotofthe new players are simply intermediariesdistributors or fintechswho (now) want to do backward integration. Thisisa fundamental tenet of business thinkingif you are selling someone else's products, at the back of your mind, you consider launching your own," he added. There's also likely to be a short-term negative fallout duetothe current wave of disruption. Clutter and product confusion will rise in an industry that already has a vast array of products. In October 2017, Sebi came out with a wide-ranging circularon the classification ofschemes. The market regulator created 26 categories of open-ended mutual funds and restricted mutual fund houses to just onescheme per category for most of them. One of the regulator's aimsin coming out with this circular was toreduce complexity amd duplication in the mutual fund world. However, as with many other laws in India, the effort came to naught. The number of open-ended mutual fund schemes ballooned from 828 in October 2017 to 1,056 in August 2021, according to data from the Association of Mutual Funds in India (AMFD. The entry of new houses has only added to this gargantuan pile. "The sheernumber of schemesand their ever-growing quantity is an issue. Today, AMCs can Jaunch any number of closeended or thematic schemes. If these are sold based on recent performance, it can resultin apoor experience for an investor," said Value Research's Kumar. However, the new entrants feel that they have abetterhandleon the pulse of India's millennials who are going to be earning and investing money over the next few decades. According to Navi's Jain, the growth inthe mutual fund investor base will come from young people (18-35 age bracket). "These investors are looking for simplicity since they are used to apps like Amazon, FlipKart, Uber and Swiggy. They expect a similar experience from MFs simplicity ofproductand technology. Today, there arearound 1,700 funds you need a recommendation engineto helpone choose what'sright for them," he said. Jainalso acknowledged that cost wasan important differentiator for hisasset management company. "Taketoday'syounginvestors. They are usedto comparing priceson multiple apps. Why wouldn't they do so with mutual funds?" he added.