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Suresh Krishnamurthy

Mutual funds and insurance policies that would suit a retail investor's quest to beat inflation over the long term at affordable costs are the need of the hour.

ALMOST all the indices are at all-time highs. Global investors are rushing to invest in India. With industrial activity too on the upswing and many Indian companies in acquisition mode, the scenario appears as rosy as could be.

The decline in the assets under management of mutual funds in recent months, accompanied by a huge increase in inflows into new funds, however, points to a problem in the market structure — the lack of long-term domestic money.

The lack of long-term domestic money in the equity market could introduce undesirable volatility into stock prices. A rally driven by short-term liquidity rather than by stable long-term funds is always susceptible to irrational swings.

The only stable long-term money in India now is, ironically, from foreign institutional investors. For the sake of balance, the stock market needs an assortment of stable domestic funds. This should include long-term close-end equity and balanced funds, pension funds and appropriately designed insurance policies along with the open-end equity funds that dominate the retail investor's landscape. Only the presence of such funds can make the market a better place for retail investors.

Investors check out: Since February 2005, asset management companies have launched several new equity funds, which have attracted record subscriptions. There is, however, evidence to believe that a significant proportion of the inflows has come in by way of transfer from existing funds.

Since February 2005, new funds have garnered Rs 13,706 crore while redemptions from existing funds amounted to about Rs 4,256 crore. Besides, large inflows into `untested' new funds, in contrast to outflows from proven existing funds, do not appear rational.

What is wrong with flows into new funds? Inflows into new funds with unproven credentials could be short-term money seeking to exit within a short time. It has been seen that in the first six months to one year of their launch, new funds steadily witness outflow.

If that trend persists in the next few months, it could lead to outflow of Rs 5,000-10,000 crore from equity funds. Volatility induced by such flows could put off scores of retail investors who are looking to invest in equity for the first time.

In contrast, if stable long-term funds dominate the landscape, they could forestall both volatile upswings and downswings. They are less prone to unnecessary and costly portfolio churn and market timing.

Portfolio churn and market timing may not add value consistently but will definitely add to costs.

Flawed marketing strategy: In selling its products, the insurance industry makes a valid point. Insurance companies point out that equity funds are short-term in their nature while insurance is for the long term. The point is valid because equity funds have become the haven for short-term investors in equity.

The marketing strategy upon which the edifice of equity funds is now being built is largely based on the frequent entry and exit of short-term money. Both brokers and asset management companies stand to benefit from this churn.

Asset management companies earn entry and exit loads. These loads are used to finance the marketing strategy of the asset management companies and also to pay fees to the brokers.

It is a fact that the mutual fund industry has delivered value to investors. Equity funds have significantly added to the wealth of its investors. Asset management companies, at the same time, do adopt questionable marketing practices. Their good performance record may now be under threat from their short-sighted marketing strategy.

Unfortunately, investors cannot turn to insurance companies. The costs charged by insurance companies and the lack of transparency in investment management does not make investing through insurance products attractive for investors.

Indian investors badly need ethically marketed investment management products. Mutual funds and insurance policies that suit a retail investor's quest to beat inflation over the long term at affordable costs are the need of the hour. It seems as if only the state-owned asset management and insurance companies can show the way in this regard.

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