It’s time mutual funds cleaned up their act and went online

At a time when the financial system is going completely electronic, the mutual fund industry has been sadly lagging in the use of internet and mobile technology.

The Indian banking system has upgraded very fast, with around 90% of all value-based transactions and 40% of all volume-based transactions taking place in the electronic form as of March 2010, according to the Reserve Bank of India. In the stock markets, 100% of transactions are in the electronic form, while in the government bond markets, 85% of the transactions are in electronic form (screen-based trading). The currency futures market too has gone fully electronic.

In mutual funds, however, electronic transactions — purchase and sale of units through internet or mobile — are barely 5% of the total.

This is not at all a good sign for retail investors, who require a product that is easy to transact, is cheap and transparent.

A retail investor who has the option to buy a Nifty ETF (exchange traded fund) can transact electronically, right from placing the order to execution, to fund transfer, to receipt of units. The same retail investor, to buy a Nifty index fund, has to fill up a form, give a cheque or transfer instruction, get a statement of holdings, put in redemptions and pay management fees.

No wonder the retail investor is not embracing mutual funds.
Mutual funds, on their part, aren’t in a hurry to go electronic, given the nature of funds and investors. Debt funds, which are mostly in the short-term category, constitute 62% of the total funds under management (Amfi, March 2011), led by corporate investors.

Indeed, corporate investors form 63% of total funds under management in the debt category and an overall 44% of the total industry assets under management. Corporate investors are sought after, wooed and placed on a pedestal by mutual funds, and understandably have a large say in how mutual funds are run.

The direct relationship with corporate sector makes electronic means of transaction somewhat redundant.

The Securities and Exchange Board of India has addressed the issue of corporates being given undue advantage in terms of loads and costs by making all investors equal.

The retail investor is predominantly invested in equities, with retail investments forming 67% of the total equity funds under management. Retail investors as a segment form 27% of the overall funds under management. The retail investor actually contributes a majority of earnings to the industry (equity funds have expense ratios of over 2%, while debt funds in the short-term category have an expense ratio of less than 0.75%). It is ironical that the least serviced and least looked after investor has to pay the highest cost and suffer the most in transacting as mutual funds have not encouraged electronic transactions.

There is also this group of high networth individuals who are serviced by private bankers and wealth managers. This investor segment forms 31% of debt funds under management and 21% of equity funds under management. Given that these individuals are serviced by wealth managers, mutual funds go all out to woo the wealth managers. High commissions, offsites in exotic locales etc are all part of the exercise of getting wealth managers on board. Again, the use of electronic form for transactions is not given importance as wealth managers do all the work for these high networth individuals.

No wonder mutual funds spend more on marketing and sales than on fund management. Reports on fund house expenses show asset management companies spend 75% or more on marketing and sales to total expenditure, while the main activity— fund management, risk management and operations — takes up only 25% of the total expenditure. Investors suffer due to poor fund management in many cases.

Mutual funds need to clean up their act. They have to reallocate resources to the electronic form for both marketing and transacting. The world is moving towards the net for marketing and mutual funds cannot afford to lag. The cheaper cost of transaction and marketing due to the use of the electronic form will give more resources for fund houses to concentrate on their main activity, i.e. fund management.    

Unfortunately, mutual funds see themselves as more of sales and marketing outfits than fund management outfits. Even in sales and marketing, where the electronic form has become the predominant vehicle, mutual funds have found themselves way behind the curve. They have a lot of catching up to do before they can start adding value to investors.