The mutual funds industry in India can be far larger: Monika Halan

Monika Halan, Author and financial educator

Monika Halan’s last book, Let’s Talk Money, was a national bestseller that offered practical insights on how to build financial security. She takes that conversation forward with her latest book Let’s Talk Mutual Funds. Halan, an author and financial educator, speaks to Forbes India about recent policy developments related to mutual funds—like the government's decision to tax investments in debt mutual funds as short-term capital gains—and how they are likely to affect investors. She also reflects on whether a large section of the Indian population has adequate income levels to invest in mutual funds, if it makes sense for people to take charge of their portfolios, and the common mistakes people make while dealing with mutual funds. Edited excerpts from a conversation on the podcast From the Bookshelves:

Q. After the huge success of Let's Talk Money, what prompted you to zoom into mutual funds?
In fact, a little bit of a heads up was there in Let’s Talk Money. Because I remember, as I wrote the chapter on mutual funds, I felt that I wasn't being able to do justice to a product that is so aimed at retail investors. In that [chapter], I had written that I think mutual fund deserves a book by itself, and then the readers and enthusiasts of Let’s Talk Money did not let me forget it; they kept on tagging me on social media and asking me when the next book was coming. So, it really is like a sequel. It takes the conversation in Let’s Talk Money forward, because I believe that for Indian retail investors, mutual funds are one of the best routes to accessing different asset classes, and, therefore, I thought it deserved a full book by itself.
 
Q. Was there a pressure to replicate the success or live up to the benchmark that you had set with Let’s Talk Money?
So, the joke within the financial industry, which I'm talking about myself, is that now I need to beat my own benchmark. In the financial sector, benchmarks are a really important part of a financial product where if a mutual fund cannot beat its benchmark, it's really not that good. So, of course, there is this idea that the book should be very good. But I think more important to me is the fact that I hope the book is useful. So, I don't know if I'm looking at numbers or if I'm looking at how I measure success. But if I'm able to modify the behaviour of a certain number of people through this book, who learn to use the product to their advantage, for me, that is success. My success is when somebody tells me or thanks me or communicates in any possible way that my work has impacted their life, that they are in a better place with their money. So, I'm, of course, hoping that the book does well, but I'm not really worrying about it.

Q. In the past few years, we've seen more investors coming into the mutual fund industry from different parts of the country. They are staying invested for a long time. The assets under management (AUM) of the mutual funds industry have doubled over the past five years to about Rs40 trillion as of November 2022. Could you help us make sense of these numbers?
The strange thing about this industry is that as the regulator [Securities and Exchange Board of India, Sebi] has gone on making the rules stricter and stricter, and more investor-friendly, we've seen investors have intuitively understood that this is a product which is catered to their advantage, to their needs, and we have seen the industry innovate very well too. So, therefore, all the stars have got aligned with this product, where the regulator has taken away upfronting of trail commissions, has made schemes true-to-label, has cleaned up benchmarks, has a dynamic risk-o-meter in place. So, all the things a retail investor requires are there.  

Now you look at another story that is playing out. One is that the regulatory endeavour and the industry’s innovation have got us a product that is really useful and relevant to the retail investor. On the parallel track, our macro story is playing out, where we are now looking at growth rates of 6 and 7 [percent]. We have grown fairly well in the last 20 years. The 1991 reforms took 10 years to unleash the sort of financial products and middle-class India, which we saw by the turn of the millennium. Now, 20 years later, we are approaching a very different space, where growth is getting stable, the aspirational middle-class cohort is getting larger. Therefore, the need for financialisation and modern financial products is there. If I look at it in that context, I will say that I think the mutual funds industry can be far, far larger—Rs42 trillion is good, but look at the size of the middle class, the size of the investing potential. I think it can be a multiplier of that.
 
But again, before we can do that, we would need a stock and a bond market that is more liquid. If I’m stitching together different stories, you do not see the AUM of the mutual fund industry in isolation, but you see it with the Indian growth story on one side, and also you need the stock and bond markets to be deeper, wider and more liquid. We need larger-ticket IPOs [initial public offerings] coming in. Because we cannot have a pipeline of retail money without there being more, very large stocks to absorb that money in the market. We need all of that to go together.  

Looking at all of that, as far as the depth of the market and growth today goes, I think we are at a good level, but going forward I really hope we get better liquidity, depth in both stocks and bonds before the size of the industry grows exponentially, because that becomes a problem.

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Q. Many people argue that the penetration of mutual funds is still low, around 10 percent, in India. How many Indians actually, at this point, have an income that is adequate for them to set aside a bit for mutual fund investments?
Anyone who can set aside Rs500 a month—which I think even the non-middle class is able to do—can actually start investing in mutual funds. An average SIP [systematic investment plan] value starts with Rs1,000 a month. That's not difficult for even people in middle-class homes and people who work for middle-class homes, like the household help, the drivers, the entire army of service providers. They can do much more than Rs1,000. So, anyone who can save Rs1,000 a month can invest very easily in this product. Now, the second part of the story is where do you invest, how do you invest? That’s what really the book gets into—What is it that you should do? How can you decode these products?

Q. What are some of the common mistakes that Indian investors make while investing in mutual funds. In your book, for instance, you talk about the ‘best returns’ mindset and say that it can often be counter-productive.  
Most investors look at mutual funds as a product that invests only in equity. That's a mistake. It doesn't. Think of this as a pipeline from your savings to different asset classes like equity, debt, gold, now real estate through REITs, and combinations of these, also foreign funds.  

So, your money is trying to get exposure to different forms of investment, different assets. If you go to buy directly, it's a lot of work and it's very difficult to construct these portfolios.  

Mutual funds allow you to do that. Most investors end up thinking that it is only equity mutual funds, because of the returns. So that’s the first error. Second is they think SIP is a product. It is a way to invest regularly, month-on-month, in a fund of your choice. The third is the returns mindset that you mentioned. You want to harvest the highest return. It is not possible to get the highest returns year after year. Today’s top-performing fund is tomorrow’s worst-performing fund. You’re buying last year’s winner if you buy last year’s best performing fund.

What I’m saying in the book is that if your scheme is in the top one quartile, which means top 25 percent, most of the time you’re good. You might even find a fund which slips into the second quartile at times, but it’s fine. A fund can have a couple of bad years as long as over the 10-,15-,20-year period, your fund keeps its head above the water in the first quartile, gives consistent returns, and has a manageable expense ratio. Perfection is a momentary occurrence in every life, so also in mutual funds. You’ll never have the perfect fund. Don’t let perfect be the enemy of good. If you have a good fund with a good return—the fund is beating the benchmark by at least 3-4 percentage points—then it makes it worth for you to do all this work to invest into an active fund where the fund manager makes choices. Otherwise, you are far better off in a passive fund, which is an index fund.
 
Q. I want to take the conversation to the point you mentioned about how a lot of people want to take charge of their own portfolios. In that context, how do you rate the performance of fund managers in the last couple of decades, because a section of retail investors feels that they can and have done better than the managers. Does that make the case for venturing on your own if you have the bandwidth?
If you have the bandwidth, what I suggest is to look at your own portfolio returns. Investors tend to only talk about their wins on one or two stocks. They tend to forget the money they have lost in either FNO [fixed network operator], or day-trading or other stocks. If you’re honest with yourself, and if you take your portfolio CAGR [compound annual growth rate] year-on-year to see what you did and whether you beat the benchmark, it’s not enough that one stock gave you a multiplier. Overall, did your portfolio beat the benchmark, are you consistent at beating the benchmark? If yes, then of course you are good on your own. But if it is like a stroke of luck, then it’s a very different story. A lot of people find it easy to make money in a rising market. When there is a downturn in the market, are you still able to keep your head over the water? Do you panic and do you sell? These are the questions you need to ask.  

Q. India recently said it will tax investments in debt mutual funds as short-term capital gains. This could potentially strip investors of the long-term benefits that made such instruments popular. What is your take on this?
I think it was very unfortunate that the Ministry of Finance did this. I think it wasn’t very-well-thought-through. The two categories of products are very different. The fixed deposit does not have market risk, which means the value doesn’t go up and down. If they say it’s 5 percent, you get 5 percent. Whereas a debt mutual fund is marked to market every day. It’s a risk-bearing product. You cannot tax the two in a similar manner. I feel this was a very bad error, a bad signal to the market.  

Having said that, debt funds still make sense. Simply because of the liquidity, the ease of using say, a liquid fund or a money market fund. For example, even if you have a sweep-in facility on your savings and fixed deposit to hold your money, a 2-in-1 account, a liquid fund still works better because the interest you get in a two-in-one account is not the five-year interest. You will get the interest which is applicable to the number of days you have held it. Whereas in a liquid fund, the story is very different. You will get the pro-rata return of the yield which is indicated. And even in terms of liquidity, you redeem today, and then if tomorrow’s a working day you get the money first thing in the morning. If you are holding the liquid fund to further invest in some mutual fund, it’s far easier to switch from a liquid to an equity fund of the same fund house.
 
So there are many advantages of still holding a debt fund over holding money in a fixed deposit. Fixed deposits, unfortunately, still remain clunky. This is not to say that fixed deposit is a bad product. If you do not understand mutual funds and you feel safe with fixed deposits, please stay there. Do not enter into debt funds if you do not understand them, because the risk may be something you cannot take. If you understand fixed deposits, please do not do corporate or cooperative bank deposits to harvest higher returns. You are taking risk that is higher than the equity market here. If you are a fixed deposit investor, stay with the large scheduled commercial banks even if the returns are lower. But for a person who understands funds, using debt funds is a no-brainer.  

Q. In March, Sebi allowed private equity funds to own mutual fund companies. Are there any challenges that you see here?
I don't think so. What I know of Sebi now and over the past few years is that a whole lot of data analytics goes into decision-making. And I've been a part of many of their committees. The mutual fund committee, I was on it for almost 12 years, and I’m part of several other committees. I’ve seen the working of this regulator very closely. Every decision is passed through a committee process which is made up of industry, veterans, consultants, people like myself who, sort of, represent the investor. I’m not selling any product, I’m not a commercial advisor. I’m really in the financial education and literacy space. Somewhere, I end up representing the retail investor. So, if Sebi is allowing private equity companies to start sponsoring mutual funds, be sure that the back-end process to ensure nothing wrong happens is already in place.  

Q. You are the also the chairperson of Sebi’s advisory committee on investor protection and education. What is your take on financial influencers of ‘finfluencers’, as they are called, who have come under Sebi’s radar recently? How do you think they should be regulated?
To the extent that they spread awareness and they get people who have never thought about investing in markets, to market, I think their role is very important. I find myself a little uncomfortable when there is product placement within the content. When we start pushing a particular product, I’m especially wary of content which carries crypto, either crypto exchange or crypto coin pitches.  

So that's one single worry for me that people tend to believe influencers, and this is the wrong signal that crypto is safe or a particular life insurance policy is good. So, I find myself not comfortable with that part of the fin-influencers.  

And the other thing is that a lot of them are very young. They are reaching the youth, the millennials and the Gen-Zs. This is a cohort that has never seen a bear market. And the confidence with which they promised three years money doubling is very scary to an old veteran warhorse like myself, who has seen, I don't know how many bear markets and how many one-day crashes that are gut-wrenching. So, I would advise extreme caution that there are very good things that they bring to the table, but in their enthusiasm, they tend to over-promise.  

Q. What are some of the biggest trends or developments that you foresee in the mutual funds industry in India over the next few years?
I think there will be more funds coming into the passive side of the market. As you know, the active funds are classified into 37 categories and every mutual fund company can have only one scheme in every category. So, there is a cap in the number of schemes you can have. In the passive part, Sebi is saying ‘let’s see what the market does’. So, I would foresee many more innovative ideas starting to come in that space.  

I’m also predicting that a lot of new firms coming into the market, and when they come in, there’s always disruption in terms of expense ratios being lowered, some facilities to investors that weren’t there coming to market. So, we see innovation mainly when younger firms, hungrier firms come to market. And I know that there is a list of companies waiting to get the licence and come to market to start offering their services. So, this is the best of capital markets, free markets, where it’s competition that will finally be in investor interest. And for competition in fair markets to work, you need a very strong regulator. I think in the mutual fund story, we have a textbook case of success of a free market, where there is a regulator making the rules of the game, we have a very aggressive, innovative industry, we have a set of distributors who have kept up with the demands that the regulator has made and turned themselves into fantastic advisors with world-class services. And the Indian mutual fund investor is among the smartest in the world. When the 2020 disaster happened in the markets, they came in to buy. It doesn’t happen anywhere in the world that retail investors buy when the markets crash. It happened in India. So, we have all three parts of the market working together. And for a policy wonk like myself—we thought of this market 20 years ago—to see it play out like this is deeply satisfying.