Equity funds -- Mirroring market movement

S. Vaidya Nathan

THE market for mutual funds in the last four years has clearly been dominated by investor preferences for income funds that invest in fixed income securities.

Equity continues to be seen as a fairweather friend depending upon the market conditions. This is because, when the market is bullish, more investors get drawn in and of late, most have gone the mutual funds route.

Moreover, funds continue to sell equity funds with a vengeance when the going is good in the market. Most such funds fail to deliver the goods, and this goes back to the early 1990s. Only if investors come around to investing in good funds in bad times for the market will there be opportunities for making gains.

The message from the experience of 1992, 1994, 1997 and 1999-2000 is clear: even if mutual funds make a hard pitch in a bullish market, investors would be better off shying away. On the other hand, strong investor preference for income products appears to have paid off irrespective of the timing of the investment.

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Equity funds too did get investor response. In the last two fiscals, close to 25 per cent of funds came into the equity funds. This is much higher than the single-digit share of such funds in 1997-98 and 1998-99. But in the last two years, investors also pulled monies out of equity funds. In the last two fiscals, close to 25 per cent of the redemptions were from equity funds.

Interestingly if one also takes into account tax-saving schemes, which invest 90 per cent of funds in equities, equity funds accounted for just 8.7 per cent of inflows into mutual funds between March 1997 and November 2000. That really shows that risk appetite for equity continues to be low. One factor in this context may also be the bitter experience investors had with equity funds through the 1990s, barring a few exceptions.

As an asset class, equities may offer the better returns over the long term and on a risk-adjusted basis. But the numbers suggest that investors may need more convincing on the ability of MFs to deliver those returns. This is also reflected in the complete lack of investor interest in tax-saving schemes that invest in equities. This category has had net outflows of Rs 1,500 crore.

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Income funds dominate inflows

Over the last four years, income funds accounted for close to 31 per cent of the inflows, and assured-return products for 7.3 per cent. But an interesting turn over the last two years is the nature of income schemes that attract support.

The entry of gilt funds and liberalisation of money market mutual fund schemes has made a difference. Mutual funds started offering treasury management funds/liquid funds, intended to bypass the restrictions on money market funds.

These funds, which essentially invest in safe government securities and short-term bank and corporate paper, attracted big support in the last two years. Apart from bank deposits flowing into such funds, the traditional income funds also shed share to such short-term debt funds. Over the last four years, the gilt/money market/treasury management funds accounted for 32.4 per cent of inflows. So overall, close to 75 per cent of funds went into income schemes, indicating the intensity of investor preference.

The short-term funds also had a high level of redemption, which is only to be expected. With the corporate sector and high-net-worth individuals being the major investors in such funds, this is not a surprise. By offering well-tailored products to target such investors, private sector funds got a bigger share of the pie.

Total picture

The Table shows that in each of the last four years, mutual funds had net inflows, though 1998-99 was a bad year, with net inflows of just Rs 156 crore. The next year (1999-2000) was a record one, with net inflows of Rs 18,545 crore on the back of a bull run in the market.

Overall if one looks at the long-term picture, over the last four years, the net inflows into mutual funds have been close to Rs 30,000 crore. Of these, equity-oriented funds attracted just Rs 2,500 crore. It is the income funds, assured return funds and short-term debt funds that dominated, with each category netting inflows of over Rs 7,500 crore each.

In two of the last four years, equity funds had net outflows -- one more indicator of fickle investor interest in such products. On the other hand, income funds had a better run, with consistent inflows.

Near-term picture

The trends in fund flows in the recent months suggest waning investor interest in equity-oriented funds -- a pointer that the long-term trend may well be here to stay for some more time to come. Clearly, with the decline in stock prices since February, the inability of almost all the funds to anticipate the denouement and protect the growth in the NAVs and the lacklustre outlook point to indifferent times for equity funds in the next few months.

In fact, the last seven months undid all the good work done by a few funds from 1995 onwards, and MFs may have a long way to go to find better credibility and takers for their products. At least as far as equity funds are concerned, a crisis of confidence has developed. This may have been because of the familiar trend of funds to push through new products in a strong bullish phase, only to find it difficult later to even protect the initial capital.

A look at the numbers shows one encouraging trend. From a long-term perspective, the increasing use of open-end funds is welcome. The advantages of such funds over close-end funds appear to be getting through to investors, with over 90 per cent of inflows in the last two years accruing to open-end funds.