Tech Invaders in the Mutual Fund Space
Mutual Fund space has opened up for startups. You could soon buy into some cool Mutual Fund schemes made by startups like Zerodha, Mobikwik, etc.
“Mutual Funds investments are subject to market risks. Read all the scheme related documents carefully before investing.”
We have all heard this disclaimer.
Yet, we don’t really care much about the market risks while entrusting our money with the ‘experts’. Do we?
After all, Mutual Fund is that friend we all trust. It is considered safe.
But have you ever wondered who those friends are?
Let’s learn about them today.
Who handles our money?
To invest in a mutual fund scheme, we approach mutual fund distributors. And these days, there are apps like ET Money, PayTM Money, MobiKwik and Zerodha through which we buy mutual funds.
But, they are not the friends that we are talking about. They don’t handle our money themselves.
Then what do these fintech companies do?
They simply hand our money over to Asset Management Companies (AMC) like HDFC AMC and UTI AMC, who then invest the money into the equity market or debt market or a combination of both.
Some of us older ones also invest through our banks. Now, the banks in most cases have their own AMC’s (HDFC Bank has HDFC AMC, Axis Bank has Axis AMC and so on). They are not required to hand the money over to other folks.
On the other hand, fintechs don’t have this option. Hence, they just collect and transfer.
But why are these fintech companies not making their own mutual fund schemes?
Because the law requires a company to at least have a net worth (assets left over after paying off all external liabilities) of more than Rs. 50 crores and a continuous profit for 5 years to become a registered AMC. After all, an AMC deals with public money, it has to be safe (read profitable), right?
Now, having a good net worth was never a problem for fintech startups. They could always make cool User Interfaces, awesome apps, and lure big-ticket investors.
The real catch lied in the profitability condition. That is something startups find difficult.
However, not having profits will not haunt them anymore.
After lobbying with the Securities and Exchange Board of India (SEBI), it’s finally a dream come true for the fintech startups in India.
SEBI has finally paved the path for big fintech companies to enter the Asset and Fund Management business. They have waived the profitability requirement to get a license for Asset Management: a decision with the potential to change the landscape of India’s Rs. 30 trillion Assets Management business (as of November 30, 2020).
A company can now enter the Assets Management business if it has a net worth of more than Rs. 100 crores even if it is not profitable.
But why are these fintech companies so eagerly wanting to enter this space?
Here, take a look at the industry’s growth over the last 6 years:
According to a CRISIL report, the Assets Under management in the Mutual Funds business will continue to grow at a double-digit growth rate and reach Rs. 50 trillion by 2025.
A lucrative business, indeed.
Currently, the Mutual Fund industry has 45 players with total Assets Under Management (AUM) of Rs. 30 trillion. However, 83% of the total business is controlled by the top 10 companies while the bottom 25 companies control only 2.5% of the market share.
The new-age fintechs will have two options to enter the market, either apply for a new license with the SEBI (the organic route) or buy the smaller Asset Management Companies (AMC) (the inorganic route). Interestingly, startups like MobiKwik and Zerodha have already applied for a license to enter the mutual fund business.
We know what you must be thinking now.
How will these fintechs change the MF business once they are in?
The new companies entering the market have a technology-oriented approach which is in contrast to the traditional businesses in the industry. So far, these businesses have thus been acting as facilitators (i.e. mutual fund distributors), and have lesser knowledge and experience in actual fund management.
But, if they have less knowledge on how to invest money in high-yielding investments, why will an investor invest in these funds?
The answer to this is simple.
With time, the industry has developed. Every other day we see a new mutual fund scheme in the market. And one such investment scheme for the fintechs to target will be the passive investment schemes.
The Growth of Passive Funds
Passive investments are funds where the fund manager is not actively involved in buying and selling shares or bonds, and there is minimal trading in the market. The funds invested follow indices like the Nifty50 or Sensex.
The major advantage of opting for passive schemes to investors is the low fees charged by these investment funds.
And this space is growing rapidly.
Not a bad space to begin with, right?
And gradually, with experience and time, they can start building active investment funds (check out the noob’s corner below to understand what active funds are).
Now, they might be lacking in experience, but there are several opportunities in the industry and strengths in their own capabilities that they can count on.
=Interestingly, the Rs. 30 trillion invested in mutual funds represent only 8-9% of the total household financial savings, and the rest are mostly held in cash or invested in low-yielding instruments like bank fixed deposits.
Even geographically, these investors are very concentrated with over 60% coming from the top 30 cities of India.
The reason behind this low penetration is simple. As the Asset Management Companies try to reach investors in smaller cities and towns, their cost of distribution increases.
This is where fintechs can make a mark.
The fintechs in the industry are mostly payment oriented and already have a deep semi-rural penetration even in the smaller towns where the current AMCs might not be able to reach without incurring heavy expenditures, as per a Business Standard article.
Adding to that, the easy to use user-interface applications with one to two clicks transaction processes could lower their distribution costs and give them a potential advantage above the traditional businesses.
A Ray of Hope
Fintech money won’t take away the share of the traditional companies. Instead, it will increase the size of the pie altogether. It is a win-win situation for all as it can lead to healthy competition in the asset management business.
The move could potentially ensure financial inclusion for the semi-urban and rural population, and take India towards a more economically equitable society.
By Pranav and Yavantika
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Noob's Corner
Active Investment Funds: These are funds that are actively managed by the fund manager and the stocks to be invested in are handpicked by him. The portfolio is constructed based on research and analysis and aims to beat the market in terms of returns, unlike the passive funds, which aim to match the market returns (by tracking a particular index).