Perspectives from ISB

This interview was first published in ISB Insight, Volume 11, Issue 1, 2013, pp55-58

Authors: Vikram Kuriyan[1] and Nupur Pavan Bang[2]

Aditya Agarwal, the Country Manager of Morningstar India, has 20 years of experience in the financial services and investment management industry. He was the promoter of one of India’s leading fund research companies, ICRA Online, and is highly regarded as a subject matter expert on mutual funds. In a conversation with Professor Vikram Kuriyan and Nupur Pavan Bang of the ISB’s Centre for Investment, Agarwal discussed the reasons for the slow growth of the Indian mutual funds industry compared to developed markets and explained why investor education and awareness is required.


India accounts for 18% of the worlds population but only 0.37% of the global mutual funds industry in terms of assets under management, as per data from the Investment Company Institute. India has one of the highest savings rates in the world at about 33% for the year 2012. But this money does not find its way into the stock markets or mutual funds. Why is this so?

It is true that only a meager fraction of the savings in India goes into stocks or mutual funds. Indians prefer real assets such as gold and property to stocks or equity mutual funds. Many risk-averse investors prefer to keep their money safe with bank fixed deposits, and some even prefer to hold cash.

The primary reason for this is a general lack of awareness among individual investors about how stock markets work. Thirty years ago, the BSE (Bombay Stock Exchange) Sensex was at 125, whereas 10 years ago, it was near 4,000 levels. Thus, if you held a portfolio of the top blue-chip stocks similar to the BSE Sensex and left it untouched, your wealth would have grown 150 times and 4.5 times in 30 and 10 years respectively, or at a compounded annual growth rate (CAGR) of about 18% in both cases.

However, in most cases, investors fail to recognise that stocks and mutual funds are best when held over a longer term, say five years or more, for the volatility to even out, and instead, trade in stocks for the short term, leading to disappointing results. Financial literacy needs to improve in the country. Despite all the efforts from the regulator and various investor education initiatives run by fund companies, financial planners, and so on, the buy-in from investors just isn’t there. Funds are still not bought; they have to be sold to investors.

It is no secret that stocks generally outperform all other asset classes over the long term – this has been demonstrated and proven in every market over different time frames; however, a relative lack of understanding of this among investors, and as a result, their bitter experience with the asset class, has resulted in Indian savings not being channeled into the asset class as much as they should be.


Private players entered the mutual fund industry in 1993. The industry is 20 years old today, but yet it is far from mature. What are the reasons for this? In terms of accountability, mutual funds have not performed well or beaten the benchmark consistently.

The entry of private players has definitely raised the standard and professionalism of the industry, but that is unlikely to have a bearing on the industry’s growth. The reason for this is that with 75% of the industry’s assets in debt and liquid funds, it serves institutions well to park their surplus funds and gain a tax advantage. Until the average retail investor starts to believe in a big way that wealth can be created from equity investments, we won’t see the industry maturing in the way it has in developed markets.

On the question of funds not performing well, we often confuse poor returns stemming from the market’s dismal performance during the past five years (five years ago, stocks were nearing the end of a multi-year bull run) with relative underperformance. One cannot expect equity funds to post sterling returns when the market itself has given zero or negative returns. At the relative level, we need to do more comprehensive studies to see how many funds are underperforming relative to their benchmarks before concluding that it is an alarming picture. It all depends on which way you look at the data.

For example, a recent study pointed out that over the past five years, over 50% of equity funds underperformed their benchmarks. But the study looked at the absolute number of funds, and not at the funds in light of their assets under management (AUM). Consider, for instance, a hypothetical category comprising two funds managing INR one billion (100 crores) and INR nine billion (900 crores) respectively. If one of them underperforms, it means that 50% of the funds underperformed. However, if the bigger fund outperforms the benchmark, then we can say that 90% of the AUM outperformed. At the asset level, a preliminary analysis we did over the same time period showed that about 80% of funds (assets) outperformed their benchmarks because the more successful funds tend to manage larger assets.


It is the perception of investors that mutual funds do not give returns. Year on year, mutual funds may perform well, but investors are actually losing money. The number of investors who lose money is greater than the number of investors who make money.

Over the long term, equity mutual funds have shown robust performance, but in the short term, stocks and stock funds can post disappointing results. It’s the nature of the beast. Investors often tend to have a herd mentality and flock to asset classes after they have seen years of outperformance and the markets are at near peaks. The recent mania for gold and for stocks towards the end of 1999 and 2007 are a case in point here; investors entered the markets at precisely the wrong time and burnt their fingers badly.

Then there is also the problem of capital-weighted return. Suppose a fund with INR one billion (100 crores) in assets gains 100% in one year. By the end of year one, due to the fund’s stupendous performance and investors chasing it and putting money in it, the asset size swells to, say, INR 10 billion (1,000 crores). Then the next year, the fund returns a negative 50%. In such a scenario, the net return at the fund level would be the same, but far more investor money would have been lost as the fund had fewer assets when it gained and more when it lost. At Morningstar, we call the concept “investor return,” and in countries where flows data is available, we often see a considerable difference between a fund’s total return and investor return (or the internal rate or return investors got, capital-weighted) over any time frame.

In markets such as the United States (US), the gap between a fund’s investor return and total return is often glaring and remains wide for some volatile categories of asset classes. We would love to see the difference between the two for Indian funds, but we do not have enough disclosure data to calculate it. However, considering that Indian markets are more volatile than many other markets and because, as we mentioned earlier, investors tend to pour in capital more often than not at the wrong time or near market peaks, we think the gap would be significantly large.

Until we have sufficient investor awareness and disciplined, buy-and-hold investing becomes more widespread, we will see the problem of investor disappointment manifest itself even if overall fund performance is good.


People in India view insurance only as a means of tax saving. Are mutual funds going the same way? If so, what can be done to prevent such a mindset?

Mutual funds will remain a push product as long as investors feel more comfortable with the 9% stable return that fixed-income instruments such as fixed deposits (FDs) provide. They tend to forget that this 9% return is often entirely eaten into by inflation and ignore the higher 20-21% return that the average mutual fund has logged over the past 10 years, albeit with greater volatility.

A big driver of this growth could be the introduction of mandatory savings into equity products by the government, something similar to the 401k in the US (a kind of defined contribution plan to save for retirement). The (National Pension System) NPS is a start, but if we revamped something like the Employees’ Provident Fund (EPF) and partly linked its returns to the market, 10 or 20 years down the line, investors would have, out of force, learned the magic of disciplined investing in stocks.

Over the course of time, as investors develop greater comfort with equities, we will see more investors come out and buy equity mutual funds.


Exchange-traded funds (ETFs) have not done well in India, whereas they are popular across the world. ETFs have only about 2% of the market share in spite of their many benefits. Is this due to weak distribution networks and low sales commissions for agents?

ETF is a wonderful product as seen by its popularity in the West, offering passive, often niche strategies for investors who focus on asset allocation. But ETFs are far ahead of their time in India. Active management is preferred here, and we do see large outperformances by managers compared to the West, where beating the market is becoming exceedingly difficult. Further, investing in ETFs in India also has its set of operational issues. One of the challenges for small investors who do not invest in stocks is the lack of a demat account. To buy an ETF, one needs to open a demat account, and not everyone wants to do that. The point about low commissions is also one of the key reasons why they are not sold as widely in India.


One argument put forward by some commentators is that if Indians prefer to invest in gold and real estate, why not give them funds that invest in gold and real estate?

We do have gold funds and ETFs that offer an excellent way to invest in the yellow metal. Real estate mutual funds are a different equation, however. Asset management companies say they face practical difficulties with respect to regulations, valuations, and so on.


Who is accountable for the performance of the funds? Do fund managers in India have the necessary qualifications to manage thousands of crores of someone elses money? A person without a background in finance may not be the right candidate to manage funds. What is your view?

As a whole, we believe that the industry’s assets are in good hands with adequately qualified people to manage the money. Of course, there will always be times when some managers are outperforming while others aren’t, but that is the nature of the market. If some are underperforming for a long time, you will see investors leaving the fund and assets drying up and going to better performing managers and funds. It is a self-correcting mechanism.

At the ecosystem level, we believe the regulator has drawn up enough regulations and put in place processes that safeguard investor interest.


What are some of the things that the Securities and Exchange Board of India (SEBI) can do to better support the industry? What are the regulatory bottlenecks that keep the industry from growing?

We believe SEBI has done a brilliant job of regulating the industry, especially after the 2004-2007 boom and subsequent crash when some of the practices were less than ideal. The abolition of entry load and the introduction of direct plans are good moves to help the investor save on expenses and make the product more attractive. The regulator has set the ground for the industry to grow in a sustainable manner. Now, it is left to market performance to pick up and start drawing in more investors, and for investor awareness to increase, all of which will launch the industry into its next growth orbit. That said, we would like to see a greater focus on independent research and higher levels of transparency and disclosure in the industry.


You spoke about research. What research topics in this industry would you advise budding researchers in India to pursue?

If the question pertains to fund research, I would like to point out the acute lack of awareness that exists in India on this subject. For many distributors, recommending funds means picking the recent top performers. At Morningstar, our unique approach, developed through decades of expertise in the field, is to offer investors not just unbiased and independent but also cutting-edge research that helps investors take informed decisions. I would urge budding researchers to try and stay up to date with the best global fund research practices, qualitative and quantitative, followed by our firm and also our peers. Knowledge, information and widening your perspective will give you an edge over others.

[1] Vikram Kuriyan is the Executive Director of the Centre for Investment at the Indian School of Business (ISB).

[2] Nupur Pavan Bang is a Senior Researcher of the Centre for Investment at the Indian School of Business (ISB).