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WHEN mutual funds were favoured in earlier years by the Finance Minister, there was an unintended positive consequence for the government. Inflows were diverted from the banking system into mutual funds. The implication was that monies were flowing into segments that did not enjoy guarantees from the Centre.

A cursory look at the size of liquid funds and the gross inflows into such options makes the point clearer. Inflows into mutual funds totalled around Rs 15,000 crore in January 2002. Around two-thirds of this flowed into liquid funds and an equal amount flowed out, indicating that it was all short-term money. The assets under management of liquid funds stood at Rs 12,600 crore. As much as Rs 4,148 crore flowed into income schemes, while an equal amount flowed out — again, a considerable amount of short-term money. The assets under management of income funds stood at Rs 55,000 crore.

These inflows and assets under management were monies diverted from the banking system. Inflows into the banking system averaged around Rs 12,000 crore in the last 12 months. For the debt schemes, inflows were around Rs 15,000 crore. In fact, experts indicated that it was a deliberate strategy to divert inflows away from central government guaranteed products. Now, with the tax efficiency of mutual funds reduced, the proportion of inflows into such products might only increase.

For the plethora of mutual fund income schemes, this poses two problems. One, performance will now count more. Only those that perform will attract inflows — both institutional and retail. Two, there will be greater attention on the costs charged. The expected yields from investing in debt products are so low that costs charged to the fund can make a significant difference.

This indirectly favours the large funds. However, large funds may not be able to perform better. It may be difficult to actively manage large funds, given the illiquid nature of the Indian debt market. So, there will be a bias against large funds. The net result is that funds of medium size with low costs may receive larger inflows in the interim.

Suresh Krishnamurthy

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