Are mutual funds good investing option when returns turn lacklustre?

As the market returns turn lacklustre and uncertainty grows, the retail investor is turning fearful. Almost all MF categories are seeing outflows, with automated systematic investment plans being the only bulwark left. While market mavens aver to the virtues of long-term investing during difficult times, what should the investors do?

If you pay close attention, you will notice that the 'investment' sales pitch during your 15-minute bank branch visit has changed. The bank officials are no longer pushing mutual funds to you. Instead, they are singing paeans about safety and guarantee in life insurance products if you are a retail customer. They are extolling the virtues of high returns in PMS (Portfolio Management Services) if you are an HNI. Mutual funds are no longer atop the pecking order for sellers.

The MF industry lobby, Association of Mutual Funds of India (Amfi), may not agree, but for many in the distribution network suddenly 'mutual funds sahi nahin hai' in a twist of fate. Flows are a slippery friend. The month of January witnessed Rs 4,130 crore of net inflows if you combined equity funds, arbitrage funds, balanced funds and tax-saving funds (ELSS). This is less than one-fifth of Rs 23,000 crore that came in January 2018. This is not a one-off.

As ironical as it may sound, life, like cricket, is a great equaliser. P M Modi's demonetisation exercise gave mutual funds a solid boost, as financialisation of assets picked up. But, a 'mahagathbandhan' of factors and events, that is, re-introduction of Long Term Capital Gain (LTCG) tax, changes to MF distribution regulations by Securities and Exchange Board of India (Sebi), and poor equity market returns, are throwing a spanner in the works of the hard work put in by fundhouses. The only MF saviour is the automated Systematic Investment Plan (SIP) with its Rs 8,000 crore a month kitty. But if returns don't improve, it is just a matter of time before they too turn into outflows. Can the fund industry reverse the trend?

Flow fundamentals

Equity-oriented schemes derive 87% of their assets from individual investors (retail + HNI). The debt funds are also getting some attention too from retail, though it is institutions that have a bigger play in debt schemes. The depressing flow picture does not change if you include debt categories. Net inflows for entire MF industry in the 10-month period between April 2018 and January 2019 stood at Rs 1.52 lakh crore, which is down more than 50% compared to Rs 3.10 lakh crore in the same period a year ago (April 2017 to January 2018).

Coming back to just equity focused funds, the absence of large sales is clearly showing in net figures. "The flows are a clear indicator. Balanced (funds' inflow) is negative. Equity funds are barely holding up. If you remove the NFO (New Fund Offer) numbers, it is clear that the ongoing open-ended funds are in net negative flow," says Aashish Sommaiyaa, CEO, Motilal Oswal AMC.

Apart from equity MFs, debt funds have also seen some niggling issues like corporate debt. This has also contributed to a kind of uncertainty not seen in the last 3-4 years. Usually, when equity markets underperform, debt funds, even with lower returns, are positioned as a stable alternative. This may not be happening as well the MF industry would have liked this time around. Radhika Gupta, CEO, Edelweiss Asset Management, says, "Equity markets are always subject to cycles and so are equity mutual fund inflows, however, in the long run, the growth outlook remains healthy. As far as debt funds are concerned, we have seen certain events of downgrades, but investors have held onto their horses and have stayed invested and there has been no major variation in flows."

Poor returns

Poor stock market returns are a big reason why the sentiment towards market-linked investment products, like equity mutual funds, has changed. It has to be mentioned that it is not right to assess mutual fund performance over short-term like six months or one year, but investors do look at near term returns."Flows typically chase returns. When returns from a category slow down, the flows to that category also slows down," says Kalpen Parekh, president, DSP Investment Managers.

After a reasonably long period of solid returns between 2014 and 2017, any form of negative returns hurt. As per Value Research website, just 15 out of the total 18 category return for one year (ended Februry 13) are negative. Only three categories, largecap, technology and international funds, have shown positive returns. "You are right – inflows have been dropping in sync with returns. It is true that many retail investors rely completely on past performance to decide whether to invest," says Gautam Kalia, head-investment products, Sharekhan by BNP Paribas.

As per Amfi data, at the end of December 2018, 29.7% of equity assets have been held for periods greater than 24 months. This means a lot of money is new money, thanks to the robust inflows received. Since December 2014, there is an increase in MF investor accounts from 4.03 crore to 8.03 crore in December 2018. But, the growth in investor accounts has also slowed. Jinesh Gopani, head - equity, Axis Mutual Fund, says, "Allocations by retail investors to equity funds does get influenced by market sentiment in the short term. Equity markets have been volatile in the last 12 months during which mid-caps and small-caps have seen sharp corrections. We believe this can be playing in investors' minds."

SIP by SIP

The only beacon of hope for mutual funds is SIPs. Money coming from this route has grown consistently grown. Since April 2018, SIP monthly collections have never dropped even for a single month. Amfi data shows that the MF industry had added about 9.31 lakh SIP accounts each month on an average during the FY 2018-19, with an average SIP size of about Rs 3,150 per SIP account. "The retail interest in mutual funds is definitely much better compared to what was over two years ago. Participation through SIP has seen impressive growth and even though the growth momentum has been tapering off, the absolute numbers continue to rise. The SIP inflows in the industry stood at Rs 8,064 crore last month - that's' almost double the figures in 2017," says Abhishek Dubey, head - strategic business development, NJ Group.

National MF distributors and IFAs (independent financial advisors) have played a big role in where the industry stands today. However, large changes have happened in how the MF distribution system works. A Sebi circular dated October 22, 2018, has banned the payment of upfront commission and mandated a full trail model for distributor commission. About 64% of the assets of individual investors are from T30 cities, brought in by distributors. Direct investments amount to 16% of individual assets: 2% from B30 and 14% from T30.

Uber Ulip

Post the changes in regulations by Sebi on reducing the expense ratio and banning frontloading of commissions, selling Unit linked insurance products (Ulips) products seems more attractive for distributors. "The insurance companies have over the last few quarters launched low-cost Ulips, benefitting investors while commission payouts are still healthy in Ulips, enticing distributors. Further, Ulips offer some unique advantages (like no income tax on gains, switch between equity and debt any number of times without any tax impact, etc) compared to equity mutual funds which offset the downsides of higher costs and lock-in/lower liquidity in case of Ulips vis-a-vis mutual funds," said Deepak Jasani, head - retail research, HDFC Securities.

Another big thing affecting sentiment surrounding equity mutual funds in the LTCG tax. The 2018 Budget announcement of 10% LTCG tax on equity investments has made returns from unit-linked insurance plans (Ulips) more attractive. Though the investment component in a Ulip works like a mutual fund, the smidgen of insurance helps ULIPs to be guided by different income-tax rules. Ulips are tax-free at maturity, unlike MFs.

Eerie election

Many investors are acquired by showing them short term trends and triggers like near term reforms or political mandates among others. Gupta, of Edelweiss, dismisses the idea that elections have a long-term impact. "As far as elections are concerned, they won't matter in the long run. Hence, it is advisable for investors to stop worrying about elections and continue to invest as per their asset allocation needs."

However, there's a need to balance the approach by furthering the idea of investing for decades. "That's where real compounding works. Investors see CAGR returns and expect this growth to take place in a linear manner. That is when the expectation mismatch happens. The solution to make the investors hold on to mutual funds longer is to promote the right investment approach - explain risk, explain cycles and make sure you have a good investment advisor,' said Parekh of DSP MF.

It is ironical that before 2014 Lok Sabha elections the mood was so different, and about five years down the line there is a perceptible change. Sousthav Chakrabarty, founder, and CEO, Capital Quotient, says: "Last time around the sentiment was much better since there was expected to be political stability. This time the election environment is quite complex with no clear favourite emerging. This has clouded the expectations that markets can have on the political front.... first-time investors have seen that markets can be quite volatile, and they haven't witnessed this degree of volatility since they began their investments."

Investor intelligence

Mutual funds are not an answer to every investment problem, some experts feel. "With the advent of multiple online platforms and apps, it was made to appear that mutual funds were the answer to every requirement. Client risk profiling, long term focus, and adequate disclosures on risk have not been properly provided or conducted," points out Chakrabarty.

Mutual fund persistency has always been a key challenge for equity funds, especially since it is linked to the impact of short term market noise. "We think that as investors improve their understanding of MFs as well as they start to use facilities such as SIPs, we should expect persistency levels to improve," said Gopani of Axis MF.

Mutual fund distributors, not just product manufacturers (AMCs), have a big role to play in educating investors. "Ulips or any other insurance product meet different needs of investors and have their own place in the retail investors' portfolio. Hence, most retail investors should not see it as an 'either or' decision between the two (life insurance versus long term wealth creation through mutual funds)," says Kalia of Sharekhan.