Rama Krishna Vadlamudi, BOMBAY January 11, 2010

www.scribd.com/vrk100 vrk_100@yahoo.co.in
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This is a curious case of equity mutual fund investors’ encashing their

investments even as Indian stock market has gone up in the last five months.
Mutual funds seem to be finding it difficult to manage the changed business
environment after the capital market regulator, Securities and Exchange Board of
India, banned entry loads on mutual funds with effect from August 1, 2009.
The following table will give you a better idea about the redemption pressure in
equity mutual funds in India between August and December 2009:

REDEMPTIONS/REPURCHASES (Rs crore)

Net Outflow Net Inflow
From January to July
From August to December 2009 2009

(7,315) 7,432 Equity MFs

Data source: AMFI

As can be seen from the above table, between August 2009 (when SEBI banned
entry loads) and December 2009, the net outflow from equity mutual funds is Rs
7,315 crore; whereas, net inflow into equity mutual funds is Rs 7,432 crore
between January and July 2009. The ban on entry loads seems to have caught
the mutual fund industry off-guard. The criticism leveled against the mutual fund
industry is that their business model till July 2009 was distributor-driven at the
cost of individual investors. All these 15 years, they were doing their fund
business in a particular way. The entry-load ban by SEBI has changed their
business complexion completely. But, the industry is yet to come to grips with the
situation. As insurance products (Unit-Linked Insurance Plans, or, ULIPs) are
more attractive for distributors, they seem to be pushing ULIPs instead of equity
mutual funds. Even though IRDA has changed the structure of ULIPs recently,
distributors still find ULIPs more attractive for getting their share of commissions.
 Rama Krishna Vadlamudi, BOMBAY January 11, 2010
www.scribd.com/vrk100 vrk_100@yahoo.co.in
MY BLOG: www.ramakrishnavadlamudi.blogspot.com

It is interesting to see how mutual fund industry would realign itself in view of the
changed circumstances. The time has come for them to focus on customer
acquisition, which is very expensive in the absence of entry loads. Due to the ban
on entry loads, mutual funds are finding it difficult to raise new fund offers
(NFOs), through which they used to rake in substantial amounts of funds. The
net assets of equity mutual funds were growing phenomenally mainly due to the
NFOs. Now, the NFO route is not possible due to the entry load ban.

More curious is the behaviour of equity mutual fund investors. Let us consider the
movement of stock market indices between August and December 2009:

INDEX 31-Dec-09 Growth over 31.7.09

Points %

SENSEX 17 464.81 11.50

MIDCAP 6 717.82 20.60
BSE-200 2 180.25 14.20

From the above table, one can observe that the Sensex has given a positive
return of 11.50 per cent against 20.60 per cent by BSE-Midcap index, between
July 31st, 2009 and 31st, December 2009. The BSE-200 broader index has
recorded a return of 14.20 per cent during the same period. This clearly indicates
that even though the stock markets have gone up steadily in the last five months,
investors have preferred to encash their equity MF investments, with net outflow
of Rs 7,300 crore (as shown above).

Before August 1, 2009, if you invest Rs 10,000 in an equity mutual fund, the
Asset Management Company or AMC used to charge 2.25 per cent or Rs 225
from your money toward entry load and the remaining Rs 9775 (10,000 – 225),
they used to invest in equities and allot units to you. Now after the entry load is
banned, if you invest Rs 10,000 in an equity MF, the entire Rs 10,000 will be
invested in equities and units will be allotted, based on the prevailing Net Asset
Value, to you for the entire Rs 10,000. Which means, now MF investors will be
saving Rs 225 or 2.25 per cent of their money. This is a substantial benefit to MF
investors. But, investors are selling out their investments instead of putting more
money in mutual funds; even though they are saving up to 2.25 per cent of entry
load.

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 Rama Krishna Vadlamudi, BOMBAY January 11, 2010
www.scribd.com/vrk100 vrk_100@yahoo.co.in
MY BLOG: www.ramakrishnavadlamudi.blogspot.com

The reasons for the strange behaviour of investors are attributed mainly to:

1. The entry load ban by SEBI wef August 1, 2009

2. Regulatory arbitrage in favour of ULIPs driving distributors towards insurance

products

3. Equity investors see the raise in indices as an opportunity to sell out and make
small profits in the process. They still seem to be afraid of the panic situation that
prevailed in 2008, when equity investors have lost very heavily.

SUMMING UP:

The entry-load ban by SEBI seems to have broken the back of mutual fund
industry; as far as raising money through equity new fund offers is concerned.
The distributors find it unattractive to push equity mutual funds and instead they
are turning towards ULIPs. Equity mutual funds have become cheaper by 2.25
per cent compared to previously. As such, investors would be better off putting in
more money into equity mutual funds according to their risk appetite, asset
allocation and convenience taking their long-term interests into consideration.

It’s time for them to invest based on the following considerations:

1. Long-term track record of three or five years of the particular fund;

2. It is a myth to assume that NFO with Rs 10 net asset value is better than an
existing fund with an NAV of Rs 100 or more. The NAV of Rs 150 (of a fund with
growth option) indicates that the fund started with an NAV of Rs 10 and since
inception its value has grown by 15 time. For example, the present NAV of
Reliance Growth fund (growth option) is Rs 437. It indicates that the NAV of this
fund has gone up by 43.7 times since its inception in October 1995. Its
annualized return (CAGR) since inception is 30.32 per cent!; and,

3. See the track record of the fund manager also whether she is able to protect
your money during any downturns. The fund manager should be able to generate
sustainable performance – not only during bull markets but protect our money
during bear markets as we have seen in 2008.

If you select your equity funds based on the above time-tested principles, you are
likely to generate decent returns provided the India Growth Story is intact for the
next five to ten years.

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