Mutual fund launches: Let’s not be condemned to repeat history

First, the Indian stock market was finally coming out of the shadow of three major scams—the Harshad Mehta scandal of the early 1990s, the Ketan Parekh scam of the late 1990s and a third scandal that almost everyone seems to have forgotten about now.

This was the vanishing-companies scam of the mid 1990s (probably the biggest of the lot), which was about promoters launching initial public offerings, collecting money and then disappearing. Investors were gradually recovering from these three shocks.

Second, that was a time when equity MFs on the whole were very small. Their assets under management, as of 30 September 2005, stood at ₹59,819 crore. Over the next six months, new schemes raised ₹22,511 crore.

Third, back then, the kind of commissions that insurance companies paid their agents was incredibly higher than what MFs paid theirs. So, the incentive to sell MFs was lower.

Fourth, it would take the Association for Mutual Funds in India, the MF lobby, many years to launch its “Mutual fund sahi hai” campaign, making MFs a mass-market financial product.

The launch of new equity schemes peaked in 2007-08, when a total of 55 schemes were launched, collecting ₹43,028 crore. In fact, most of the schemes being launched were essentially similar to what asset management companies (AMCs) running MFs already had. So, why launch new ones?

Ultimately, the more money an AMC manages, the more money it earns. And it so turns out that it’s easier to raise money through new MF launches at a point when the stock market is going from strength to strength, as it was in 2007-08. The BSE Sensex rose by 60% from the end of March 2007 to its then all-time high of 20,873 reached on 8 January 2008.

When markets are doing well, AMCs can tell a bright story to sell a new scheme. The story being told and sold was of India’s growth—that India would be the next China and stock prices will continue to go through the roof, which was why you should buy this newly launched scheme.

The irony was that the India growth story wouldn’t just benefit new schemes, it would also benefit the schemes already in existence. Of course, fund managers did not get into such inconvenient details.

So, why is it important to recount all this history right now? In June 2024, AMCs launched 11 new schemes, raising ₹14,370 crore. In fact, it’s not as easy to launch a new equity MF now as it was in the 2000s.

In October 2017, the Securities and Exchange Board of India (Sebi) categorized equity MFs into 10 different kinds, like large cap funds, mid cap funds, value funds, sectoral/thematic funds and so on. It said that “only one scheme per category would be permitted” except in case of index funds on different indices and sectoral/thematic funds, which invest in a particular sector or theme.

This is where the loophole lies. Nine out of the 11 new equity MFs launched in June belong to the sectoral/thematic category. These schemes raised a total of ₹12,974 crore. Now, some of the sectoral funds being launched are going to invest in sectors that are already at very high valuations.

As for thematic funds, in themes like consumption, business cycle, special-opportunities or innovation, a fund manager can practically invest in any stock and justify it with some fancy English. This essentially allows AMCs to launch schemes that are similar to schemes already in existence, but new in name.

The story, as was the case in 2008, helps them raise more money at a time when stock valuations are really stretched. But then, the more money that is invested in their schemes, the more money AMCs make.

What AMCs seem to have forgotten or are probably ignoring is what happened after 8 January 2008. In 2007-08, AMCs had raised ₹43,028 crore through 55 schemes. From April 2008 to May 2017, AMCs launched 264 equity MF schemes that managed to raise a total of ₹42,540 crore.

In June 2017, four new equity MF schemes were launched and these collected ₹1,957 crore. It was at this point that the money collected through new schemes post 2007-08 crossed the money collected just during 2007-08—a period of more than nine years.

This happened because AMCs had chosen to launch new equity schemes at a time when stock valuations were very high. Retail investors who had rushed to invest in equity MFs either lost money or earned very low returns once the stock market crashed after January 2008.

Something similar may be happening right now, with money being raised when valuations are at extremely high levels. But then, no Cinderella has ever been worried before the clock strikes 12. The going is good so long as the going is good and those in the business of managing other people’s money currently live in a world that did not exist before 2020.