Entry Load Ban and its Impact in India

India’s mutual fund sector has traditionally been dominated by investments from the institutional investors, namely banks and financial institutions, non-financial corporates and foreign institutional investors. However, mutual funds are primarily vehicles for retail investments. Retail investments accounted for 51% of India’s mutual fund industry AuM in 2012-13 growing from 43% in 2008-09. While the growth in share may be due to a temporary decline in institutions’ share, retail investments has grown continuously in recent years. More importantly average holding period has gone up in recent years. The practice of charging mandatory entry load was abolished by SEBI to reduce churning, since distributors would encourage investors to prematurely terminate their investments and make new investments as that gave them more commission. Since equity funds earned the highest commission, we analyze the changes in average holding period for equity investments from retail investors. It can be seen that proportion of investments held for over 2 years has gone up, for both retail investors and HNIs. This has come largely at the cost of investments held for between 1 and 2 years. The share of investments held for less than one year has remained more or less same during this time. This is perhaps due to the fact that distributors would typically not ask investors to churn their investments within a year of investment, but afterwards. This trend therefore suggests that the abolition of entry load has indeed resulted in investors holding on to investments for longer duration, and thereby engaging less in churning. holding period We discuss this and other key issues pertaining to the Indian Mutual Fund Industry in a new report.

IPO Pricing Issues in India

One of the most important issues in floating an IPO is the pricing aspect. Different forces, often in conflict with each other, are at play here. Issuers would ideally like to maximize the proceeds from the process. Investors would want the offer to be under priced at best and to be (near) correctly valued at worst. Underwriter gets a portion of capital raised as fee, and they would want to maximize their income. But if an IPO is overpriced, there may not be sufficient demand from the market and as a result the issuer may not be able to sell all the shares it had planned. The reputation of the underwriter is also at stake here. It has been observed from empirical data that historically IPOs have been under priced. However, the trend regarding pricing of IPOs seen in India over the last one year has followed an opposite pattern. It has been observed, 70% of the 55 firms that went for IPO during the period April, 2010 to March, 2011, are trading below their offer price. Moreover, 70% of the same 55 firms traded at premium on their listing days, but price fell on subsequent trading days. This implies only very short term investors have actually benefited from these offerings. This is even more surprising when one considers IPO performance in conjunction with overall market performance. In August 2009 BSE created an IPO index that tracks the value of companies for two years after IPO starting from the third day of trading. The graph shows the movement of this BSE IPO index along with that of the SENSEX. It is noteworthy, while the two moved in tandem initially, they have diverged from each other since September, 2010. Thus while the SENSEX gained over 10% during April 2010 to March 2011, BSE IPO index fell over 15% during the same period. This implies overall market condition is not to be blamed for the poor performance of the newly listed firms. This does not augur well for the markets. Retail investors, most of whom invest with medium to long term objectives and are not very sophisticated or well informed, suffered heavy losses and may lose interest in the IPO segment. The pricing of IPOs has come under scrutiny from a number of market participants and the capital market regulator, Securities and Exchange Board of India (SEBI), has taken note of the situation. In the past SEBI had expressed its displeasure regarding overpricing of IPOs and asked the underwriting banks to be more prudent regarding IPO pricing. Recently SEBI proposed that underwriting banks must disclose to investors the performance and track records of their earlier issues in their prospectus and on website. The regulator is also concerned about hyping of public issues through misleading advertisements and media reports and could propose strict penalty if underwriters are found to be involved in such activities. Moreover, SEBI has expressed its displeasure over investment banks, vying among each other to bag deals, quoting very low fees from issuers, thereby promoting issuer interest above investor interest.

Trends in Indian Mutual Funds since Abolition of Entry Load

The Securities and Exchange Board of India (SEBI) has undertaken a number of initiatives and brought in new regulations for the mutual fund industry in the last two years, the most important change being the abolition of entry load for selling mutual fund products since August 2009. The effect of this rule change has been widely debated. Some argue the impact of this change has not been significant as fund flows have registered year on year growth in 2009, while others argue that in absence of upfront commission distributors are now less motivated to sell mutual funds. We take a look at quarterly sales data of equity mutual funds to analyze the effect. Sales of euity funds, which constitute a third of industry AuM, is a good proxy to understand retail investor buying behavior, because the retail (including HNI) segment accounts for around 85% of total equity fund assets. According to data from AMFI, quarterly sales have been steady since the second quarter of 2009, and higher than they were in 2008. However, one needs to decouple the effects of the crisis that hit the markets in 2008. From the figure, one can conclude that though equity fund sales grew after the rule change, they are still far below the trends observed during 2006–2007. The decline in 2008 was due to market conditions, but subsequent recovery has not been commensurate with overall market improvement. Equity fund sales moved in tandem with SENSEX in the pre-2008 period, but post-2008 the gap has widened. Two points are worth considering here. The crisis of 2008 may have made investors more risk averse. While they were buying heavily during the bull run of 2006-07, post-crisis they have become apprehensive of investing in mutual funds. Another reason for lack of investor participation can be the lower returns generated by the fund managers. A recent study by Standard & Poor’s and CRISIL showed that a majority of actively managed mutual fund schemes in India have underperformed their respective benchmarks over the five-year period ended December 31, 2010. This may have made retail investors shy further away from investing in mutual funds. In summary, it can be said that the recovery of the Indian mutual fund industry since the crisis of 2008 has not been commensurate with the overall market recovery. The abolition of entry load has had an impact on sales from the retail segment, but it is not the only reason. Failure to outperform benchmark indices is another equally important issue afflicting the industry.

Quarterly Equity Mutual Fund Sales

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The Securities and Exchange Board of India (SEBI) has undertaken a number of initiatives and brought in new regulations for the mutual fund industry in the last two years, the most important change being the abolition of entry load for selling mutual fund products since August 2009. The effect of this rule change has been widely debated. Some argue the impact of this change has not been significant as fund flows have registered year on year growth in 2009, while others argue that in absence of upfront commission distributors are now less motivated to sell mutual funds. We take a look at quarterly sales data of equity mutual funds to analyze the effect. Sales of euity funds, which constitute a third of industry AuM, is a good proxy to understand retail investor buying behavior, because the retail (including HNI) segment accounts for around 85% of total equity fund assets.

According to data from AMFI, quarterly sales have been steady since the second quarter of 2009, and higher than they were in 2008. However, one needs to decouple the effects of the crisis that hit the markets in 2008. From the figure, one can conclude that though equity fund sales grew after the rule change, they are still far below the trends observed during 2006–2007. The decline in 2008 was due to market conditions, but subsequent recovery has not been commensurate with overall market improvement. Equity fund sales moved in tandem with SENSEX in the pre-2008 period, but post-2008 the gap has widened.

Two points are worth considering here. The crisis of 2008 may have made investors more risk averse. While they were buying heavily during the bull run of 2006-07, post-crisis they have become apprehensive of investing in mutual funds. Another reason for lack of investor participation can be the lower returns generated by the fund managers. A recent study by Standard & Poor’s and CRISIL showed that a majority of actively managed mutual fund schemes in India have underperformed their respective benchmarks over the five-year period ended December 31, 2010. This may have made retail investors shy further away from investing in mutual funds.

In summary, it can be said that the recovery of the Indian mutual fund industry since the crisis of 2008 has not been commensurate with the overall market recovery. The abolition of entry load has had an impact on sales from the retail segment, but it is not the only reason. Failure to outperform benchmark indices is another equally important issue afflicting the industry.