Blackmoney crackdown: Inflection for Mutual Fund industry

The current regime of demonetisation is a revolutionary step having far-reaching impacts and mutual fund industry will of course, won’t remain untouched.

Modern mutual fund industry in India started in 1993 with entry of private sector asset management companies. Until then, industry was largely a government owned body with UTI being the biggest Asset manager. From 1993 to Jan- 2003, assets in the industry moved from 47000 crores to about 120000 crores, a growth rate of about 10% CAGR. From about Feb 2003 to till date, the industry has moved 13 times to 16 lakh crores, a compounded growth rate of whopping 22%!

However, this is not even the tip of the iceberg! Assuming an average of 4 folios per investor, there are barely 1.25 crore unique mutual fund investors in a country of 127 crores. In USA, 1 out of every 2 households invest in mutual funds, in India the ratio isn’t available but is higher than 1 in every 100 households. With a savings rate of 28%, these households are definitely channelizing their surpluses to some alternate investment avenues and not mutual funds.

We feel government’s crusade against Black Money, will benefit the mutual fund industry in long run and channelize lot of household savings from cash, gold and real estate to financial assets in general and mutual funds in particular.

Here’s a close-down on how this transformation will unfold in coming decade:

1)      New KYC verified client base: Every Indian who goes back to the bank to tender Rs. 500/1000 notes will get KYC verified, latest credentials will be updated and established in KYC registers. With central KYC in place, this updated KYC, sooner or later, will find its way into the Mutual Fund industry as well. One of the frequent complaints of Mutual Fund industry has been that not many investors want to undergo a new KYC process and once this new database is made available through central KYC mechanism, this will throw the doors ajar for a large section on new investors.

2)      Diversion away from Gold & Real Estate: There are several estimates and reports suggesting that this surgical crackdown on cash economy will lead to diversion away from gold and real estate. Not only will people buy less of these due to non-availability of black-money, but will also stay away owing to fear of massive correction in prices. This leaves investors with very little choice but to divert their savings to financial instruments to earn real returns. And we believe, Mutual funds being fairly simple products and because of their tax-friendly status will be the largest beneficiaries.

3)      Falling Interest rates: One can argue, that majority of Indians will continue to put bulk of savings in safer instruments like fixed deposits, post-office savings and savings bank accounts. However, we feel that with this crackdown on black money, there will be a significant demand slow-down leading to inflation dropping significantly. This should keep the interest rates subdued for a fairly long time now and our interaction with economists suggest a strong likelihood of rates falling further by as much as 1% in coming year. This will render instruments like deposits fairly unattractive for large sections of population and hence, leading to significant inflows in mutual funds.

4)      Move away from Cash: Psychological impact of this measure cannot be undermined in the long-run. This will lead to long-term changes in habits and behaviours of people and drive them to use more of plastic money, cheques ande-wallets. All this will in turn lead to significant surge in cash balances in the banking system. Indians hold a massive 17.5 lac crores in cash (almost 12% of their overall financial wealth). In advanced countries, the % of cash to financial wealth is below 5%. With a conservative estimate of 10% shift from cash usage to electronic means, it could lead to 1.75 lac crores of additional flows in the system. Some of this will be more systemic in nature and will find its way into financial instruments like Mutual Funds and stock over a period of time.

5)      Held wealth in Physical Assets: Point (2) analysed how future investments might stay  away from real estate & gold owing to expectation of falling prices in these segments. However, we haven’t spoken as yet of the biggest avenue of accumulated wealth for Indians – physical assets in general and Gold/Real Estate in particular. As per Karvy’s latest wealth survey, Indian individuals hold a mind-boggling 119 lac crores in physical assets (42.75% of their overall wealth). Gold and real estate put together contribute 110 lac crores out of this. With black cash economy reset to zero for the time being, these physical assets could go through painful cycles of price correction. Not all investors have the appetite to bear losses and ride through painful downtrends. Hence, this could lead to large exodus of retail investors from these instruments. The immediate beneficiary of this will be financial instruments. It’s anyone’s guess on the quantum of this movement, but even a 5-10% movement from physical to financial assets, will lead to tectonic shifts in investing patterns of this country!

6)      Unorganised Lending: We are all familiar with the big unorganised lending market in the country. Lending on security of jewellery at crazy rates of 24% & above is quite a prevalent practice in smaller towns. This crackdown on cash economy could lead to a massive cycle of defaults on such loans, in many cases permanently driving away the lenders from this risky & tax-evasive way of loaning surplus funds. There can be no estimate to this, yet, this diversion could over a period of time all find its way to legitimate sources of investments.

As incentive to keep large cash balances come down and incentive to invest in assets like gold and real estate fade away, mutual fund industry should witness one of the most promising decades of growth from hereon.  Notwithstanding this will be helped by several interlinked factors like fall in gold imports, fall in inflation leading to lower interest rates in economy, fiscal deficit improving significantly, currency strengthening, banking system getting huge deposits and hence being able to lend more freely & at cheaper rates to businesses etc.

In nutshell, this could be a historic inflection point for mutual fund industry, the very spark that could potentially usher the next decade of hyper-growth in financial assets. So fasten your seat belts, ride the interim volatility for next 6-12 months and be assured to reap the fruits of this revolution for years to come by!