Current Issues in Mutual Funds Industry

Ashish M. Shaji

11 Aug, 2021

The economic slowdown due to the Covid-19 pandemic has had a severe impact on a number of industries. The Mutual Funds Industry is no different which has faced a lot of challenges, not only owing to the pandemic induced economic slowdown due to COVID 19 but also due to some specific events.

What are the challenges for the growth of Mutual Funds Industry?

The Mutual Funds industry, despite registering a growth of 20%, has only two crore investors. This tells you that the industry is under-penetrated. Although technology has played a critical role in reaching out to a large audience, a lot of work is yet to be done.

The footprints need to be expanded by opening branches in locations that are underserved. There is a need for investor education initiatives to continue, and the industry must maintain momentum. Equity is still the primary asset class for the retail investor, but promoting debt mutual fund schemes is equally essential. The promotion of such schemes can help in tackling the present-day challenge of the slow growth of this industry.

Issues with respect to Debt Servicing and Liquidity

The Securities and Exchange Board of India recently allowed valuation agencies appointed by AMFI (Association of Mutual Funds in India) to not consider as default any delay in payment of interest/principal or extension of the maturity of security by the issuer in case it has arisen only due to the Covid-19 pandemic induced lockdown or the RBI moratorium.

It will reduce the immediate pressure to some extent in terms of devaluation of the instruments, but it could look like a quick fix or postponement of the default to a later stage without taking the steps for value preservation or value enhancement.

Even prior to the lockdown, the issue related to liquidity was prevalent, and the RBI was sought for a solution. The present issues like liquidity concerns and issues relating to high-risk credit are not new. It has been there for the last few years. The Reserve Bank has announced a liquidity facility for mutual funds and has opened a 50,000 crore rupees window for high-risk debt mutual funds. The scheme was available from 27^th April to 11^th May, unless the allocated amount is used earlier.

Here, the preferred mechanism to infuse liquidity is the repo window that operates under the Liquidity Adjustment Framework as per which the Reserve Bank lends to banks for specific on lending to mutual funds. Such exposure to mutual funds shall be exempt from capital market exposure limitations as per the current prudential regulations applicable to banks.

What are some of the other issues faced by the Mutual Funds Industry?

 The Mutual Funds Industry still face certain issues in terms of-

• Customer Engagement and Education

Investors have been unaware of the benefits of investing in mutual funds. It is because financial literacy and financial inclusion have been low. The investors must be educated about risk-return, asset allocation, fund objective, portfolio diversification, fund switching, etc. If the financial health of the investors is not taken care of, then arising issues are inevitable.

• Product centered approach

The industry is product-centered, and it falls short of the expectations in meeting the needs of the customer, especially at the time of economic uncertainty and market volatility. Therefore there is a need for the industry to be customer-centered. A large number of mutual funds schemes can make investment decisions difficult and complex KYC norms, submission of documents, etc. further restricts the investors.

• Shortage in types of mutual funds

There has been a shortage in the types of mutual funds available in the market, and the available products don’t meet all requirements of the people. There is a paucity of new innovative products, and products like real estate funds, hybrid funds, and exchange-traded funds do not have many options. The products with capital protection or safety features must be devised to tackle this challenge.

• Shrinking margins and consolidation

Events such as the global economic crisis, increasing fund management costs, upper limits on fund charges, increasing challenges, and competition in the industry has made it difficult for small players to survive. Consolidation is expected to bring stability to the industry.

• Regulatory Framework

Although the regulator i.e., SEBI, has introduced several measures to protect the interests of the small investors still there is a requirement of more proactive, robust regulatory implementation and compliance systems supporting the growth and the needs of the industry.

• Cost Management

This is another issue hounding the MF industry. The ever increasing charges of fund management can never be allowed, especially when the profit margins are shrinking. There is a need for better cost management, and excessive churning of investments and asset-liability mismatch should be reduced.

How long can technology help in resolving the issues in the Mutual Funds industry?

Apart from the substantive issues, there are also procedural difficulties in the system. At a time when the country is under lockdown, there is a need to move to a digital platform for reducing the procedural challenges to some extent. Investment in technology has brought results, and it is expected to be the most significant enabler for growth as mutual funds have witnessed increased traction from online channels such as fintech platforms, etc. 

Fintech platforms can be helpful in this space, and there are some players working towards it. It would be useful to have the regulator sponsor on these platforms to ensure better outreach.

Conclusion