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Mutual Funds:

Ready for the


next leap
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2 Mutual Funds: Ready for the next leap


Contents
1. Overview................................................................................................................ 4
India: a promising outlook
Key growth drivers for Indias mutual fund industry
Trend in growth and overview of current state of Indias mutual fund industry

2. Global best practices in asset management products................................................. 10


A nalysis of global assets under management across asset classes
Key trends:
Rise of specialty products and investment solutions
Move to alternative products
Trend in global pension funds

3. Products: Indian Scenario........................................................................................ 18


verview of Indian mutual fund asset classes
O
Regulatory initiatives related to mutual funds
Fund houses focusing on new types of product offerings
Exchange Traded Funds (ETFs) in India
Pension fund sector in India

4. Digital..................................................................................................................... 24
K ey global wealth and asset management trends in digital
Digital technologies transforming asset management space

5. Digital: Indian scenario............................................................................................ 32


T echnological advances transforming Indias mutual fund sector
Digital helping enhance distribution

6. Regulations............................................................................................................. 36
Global best practices
K ey regulations affecting mutual fund industry across the globe
Key rules in global regulations that may impact the Indian mutual fund regulatory regime

7. Goods and Services Taxs (GST) impact on the mutual fund sector.............................. 46

Mutual Funds: Ready for the next leap 3


1.
India:
a promising outlook

4 Mutual Funds: Ready for the next leap


India is likely to emerge as one of the worlds top three growing economies by 2020. Investors also believe that India will be
among the worlds top three destinations for manufacturing and develop into a regional as well as global hub for operations
in the next few years.

According to EYs 2015 India Attractiveness Survey, 32% of the respondents ranked India as the most attractive investment
destination globally, while 60% placed the country among the top three investment destinations. The countrys vast domestic
market and low-cost, skilled labor market continue to be its most attractive features.

Rank the three most attractive markets for investment


in the next three years (three possible answers)
2015 2014
India 32 % 60% How do you see India in 2020?
China 15 % 47%
Among the top
Southeast Asia 12 % 38 %
three growing
37 % 29 %
Brazil 5% 27% economies in
the world
North America 10 % 21%
Latin America 3 % 18%
Among the worlds
Middle East 4% 17%
leading three
Western Europe 3% 12% 35 % 24 %
destinations for
Northern Africa 4 % 11% manufacturing
Central Eastern Europe 3 % 10%
Sub-Saharan Africa 3 % 9% A regional and 9%
global hub for 21 %
Japan 3 % 9% operations
Russia 1% 6 %
Commonwealth of 1% Source: EY's 2015 India attractiveness survey
Independent States (CIS) First mention (respondents: 250, asked to half of the sample).
Can't say 2% Total mentions
Source: EY's 2015 India attractiveness survey (total respondents: 505).

A buoyant today and tomorrow

Today Tomorrow
GDP growth: 2.5 times Youngest 29
in the past 15 years country in the 100 million new
world by 2020, manufacturing jobs
GDP per head growth: 3.3 times with median through the Make in India
in the past 15 years age of 29 program by 2022

Foreign exchange reserves 65 million new


houses by 2022
growth: 7 times in the past 15 years
475m
Indian e-commerce market 475 million
to reach US$43b in the middle-class
Third-largest economy next ve years Indians by 2030
in the world US$
US$ 43b 50m
by purchasing-power parity 10b
after the US and China 2014 2019 2012 2030

Sources: Oxford Economics Database; United Nations Conference on Trade and Development;
World Bank; IMF; EY Rapid Growth Markets Forecast, EY, July 2014; Nomuras India Internet Report.

Mutual Funds: Ready for the next leap 5


Key growth drivers for Indias mutual fund industry

Strong macro-economic Current low penetration in


fundamentals terms of investor wallet share
In 2015, India overtook China to become the fastest In India, the mutual fund AUM/GDP ratio is significantly
growing major economy globally, with a GDP growth low at 7% (as of 2015), compared to 114% in Australia,
rate of 7.3%. GDP growth is expected to increase 91% in the US and 51% in the UK. Mutual funds
further to 7.6% for 2016, driven by strong farm output have not yet been able to gain a significant share
and an improvement in electricity generation and of investors wallet mainly due to lack of financial
1
mining. In the past few years, the pace of wealth awareness among a major portion of the population.
creation has been much faster. According to World Mutual fund investments accounted for only 3.4%
Bank data, after taking 60 years to become a US$1 of total investment in financial assets by individual
4
trillion economy, India added the next trillion in only investors in FY15. This underlines the significant
seven years and crossed the US$2 trillion landmark in untapped potential for growth in the Indian mutual
2014. The expected per capita gross national income fund industry. Moreover, there is lack of healthy
growth over the next decade could propel India in to participation from investors in beyond top-15 (b-15)
2
the upper middle income country category. Strong locations. As of March 2016, 85.8% of the mutual fund
underlying economic expansion along with significant industry AUM came from the top 15 cities, while the
growth in per capita income will drive investments remaining 14.2% came from b-15 locations. Recently,
across financial products, including mutual funds. with improved distribution and regulatory changes
Strong macroeconomic fundamentals could also to fee structure, the mutual fund sector is witnessing
facilitate further development of capital markets and rising activity from b-15 locations, especially in the
5
drive retail investor participation. equity segment. SEBI is also keen on deepening
mutual fund penetration beyond tier I cities in India.

Favorable demographics Government initiatives are driving


and rising income levels investments from global investors
India benefits from favorable demographics. With The Governments ongoing efforts to revitalize
more than 50% of the population under 25 years of growth with various new initiatives such as Make in
age, Indias falling dependency ratio provides strong India, Digital India and 100 Smart Cities have been
support for long-term growth. By 2021, 64% of Indias critical in driving Indias attractiveness among foreign
3
total population will be in the working age group. investors. The Government aims to improve Indias
Millennials are the largest and fastest-growing adult rank in the World Banks Ease of Doing Business index
segment across the globe and represent the greatest (of 183 countries) from 142 to 50 within the next
opportunity for the asset management industry, few years by cutting red tape and using technology to
6
as they are not only growing in number, but also increase transparency. It has also introduced a ranking
accumulating assets at an impressive rate. Favorable of Indian states based on their ease of doing business,
demographics, rising income levels and a burgeoning fostering healthy competition to attract investments
affluent middle class will provide a strong customer and create jobs. Foreign investment in India is also
base for the mutual fund sector. booming. India was the top destination for foreign
direct investment (FDI), attracting 697 FDI projects
worth US$63 billion in 2015. Make in India and the
resultant boost has also resulted in a significant jump
in FDI job creation from 1,16,000 jobs in 2013 to
7
2,25,000 jobs in 2015.

1 5
Growth star India overtakes China as worlds fastest growing major AMFI; EY Analysis; Mutual fund assets: Smaller cities share on rise,
economy, The Telegraph, 8 February 2016; GDP: At 7.6%, Indias growth Business Standard, 27 April 2015; MFs asset base from B15 cities jumps
points to fastest growing large economy, The Indian Express, 1 June 2016 19% to Rs. 2 lakh cr, Business Line, 25 August 2016
2 6
India is now a $2-trillion economy, The Hindu, 3 July 2015 India: can the fastest-growing large economy sustain its pace?, BNP
3
The rise of the millennials, Livemint, 1 Dec 2015 Paribas, 14 June 2016
7
4
EFMA, Oxford Economics, EY Analysis ; Karvy: India Wealth Report, India replaces China as top FDI destination in 2015: Report, The Economic
2015; Factors that impacted the fund industry in 2015, Morning Star, 29 Times, 21 April 2016
December 2015

6 Mutual Funds: Ready for the next leap


Trend in growth and overview of the current state of Indias mutual fund industry

Mutual fund AUM (INR billion)

1964 87: UTI is 12,846.6


1996: Formulation of
the sole player SEBI (Mutual Fund)
Regulations 1996 During 2006 -2008:
Several foreign 10,828.0
under which the
1987: Several public industry currently rms enter
sector players,
including PSBs, enter
8,252.0

1993: Private 7,025.0


sector players 6,139.8 5,922.5 5,877.0 2015: Robust equity
enter; the rst
inows result in equity
mutual fund 5,051.5 AUM crossing INR4
regulations come 4,173.0 trillion in December
into existence

2014: The MF market


2003: UTI bifurcates into two with scales new highs as it
1,218.1 a specied undertaking in charge surpassed INR10
470.0 of assured return schemes trillion for the rst
0.3 45.6

FY65 FY87 FY93 FY03 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16
Source: AMFI

Record AUM growth since 1990s Competitive landscape dominated by large


players
The formation of Unit Trust of India in 1963 was a significant
milestone in the evolution of Indias mutual fund industry. The industry is currently dominated by large financial
However, the MF sector gained significant traction after the services firms, which also have interest in banking and
entry of private players in 1993. The industry has seen rapid insurance business. The market share of the top 10 players
growth since 1990, both in terms of AUM size and number amounted to 79.5% in March 2016, while the top 5 players
9
of players. Allowing the entry of private players brought held a 55.6% market share. Small and medium-sized
in capital to fund growth, helped in product development players have not been able to make significant inroads and
and led to expansion in the reach of mutual funds. SEBI has are feeling the pressure of escalating costs and shrinking
introduced significant regulatory reforms over the last two revenues. Foreign players have also found it difficult to gain
decades to increase mutual fund penetration, adopt global a strong foothold. Foreign fund houses accounted for only
best practices in governance and transparency, and also 8% of assets, with their inability to grow beyond a certain
ensure investor protection. All these factors combined led to size compelling them to exit. In the past six years, seven
10
an increase in the mutual fund industrys AUM from INR470 foreign players have exited. This is leading to consolidation
billion in March 1993 to INR12.85 trillion in March 2016. in the industry, and the mutual fund business in India is
Particularly during the last year, strong participation from becoming more concentrated.
retail investors and robust inflows into equity mutual funds
drove strong growth in AUM, with equity AUM crossing the
INR4 trillion landmark for the first time in the history of the
8
Indian mutual fund industry in December 2015.

8
 Mutual fund industrys asset base surges 21% to Rs 13.4 lakh cr in 2015, The Financial Express, 3 January 2016
9
AMFI
10
Wall Street gives up on India mutual funds as JPMorgan joins exodus, Mint, 13 April 2016

Mutual Funds: Ready for the next leap 7


11
Increased retail participation
Investor class wise AUM (%) The industry has been successful in improving the
share of retail and high net worth individuals (HNIs) in
total AUM from 43% in March 2009 to 51% in March
50.9% 46.9%
4.6% 1.2% 2016. According to AMFI, mutual funds added 5.9
million folios in FY16, of which 5.45 million were
0.9%
22.0% 1.2% 28.6% retail folios. As of March 2016, total mutual fund
folios amounted to 47.7 million, of which 45.4 million
21.3% 22.4%
were retail folios.
Mar-09 Mar-16

Retail HNIs FIIs Banks/FIs Corporates


Source: AMFI

Lack of widespread financial literacy among investors has been one of the key impediments to further penetration of mutual
fund products. SEBI has been at the forefront of taking initiatives to increase awareness. The relentless effort and significant
time invested by SEBI and AMCs in spreading awareness have increased the familiarity of retail investors with investment
jargons. Increased financial awareness will, in turn, be instrumental in driving higher retail demand for mutual fund products.

The robust AUM growth of the past decade is expected to continue going forward, driven by developments
across the following areas:

Global best-practices / key trends Indian scenario


Products G
lobally, the mutual fund industry is well established; T
he Indian mutual fund industry has witnessed record
Europe has the largest number of funds, while the US AUM growth over the past two decades
dominates in terms of AUM; notably, the penetration of H
owever, mutual fund penetration is still low and the
funds is low in Asian markets industry has high potential for growth
T
he global asset management industry is witnessing a D
ebt funds dominate the AUM mix; however, equity
shift in flows from traditional mutual funds to alternative funds have driven AUM growth recently
products; passive investing and liquid alternative mutual
S
EBI needs to focus on rationalizing similar product
funds are becoming popular in the western world
offerings
S
tellar growth of ETF products continues in western
N
ew types of product offerings such as REITs and AIFs
markets
are expected to drive growth
P
ension assets have reached a new high (amounted
E
TFs are likely to gain popularity going forward with
to US$35 billion in 19 major markets); there is a shift
increasing maturity in financial markets
towards defined contribution (DC) plans and increasing
demand for investment solutions T
here is a need for deepening pension coverage in India
Digital T
he rise of direct-to-consumer (D2C) distribution is T
echnological advances are also transforming Indias
changing the rules of engagement for asset managers mutual fund sector
T
echnology is helping asset managers revamp their P
rocesses are becoming paperless, efficient, easy and
business models standardize, centralize and outsource real-time
T
ech giants are emerging as threats to traditional fund D
igital is helping fund houses enhance distribution
houses reach; industry-wide digital platforms, such as platforms
M
obile, social media, big data, analytics, cloud- by stock exchanges and MF Utility, are facilitating easier
computing, blockchain, FinTech and robo-advisors are distribution
shaping the future of asset management S
EBI is also planning to allow e-commerce firms to sell
MFs
R
obo-advisors will help in distribution
Regulations A
more stringent regulatory environment for the asset S
EBI has introduced significant regulatory reforms for
management industry is evolving after the global the mutual fund industry over the past two decades
financial crisis S
EBI is pushing for a more transparent, investor-friendly
M
ultitude of regulations in overlapping areas is leading and less risky mutual fund industry in India
to the emergence of a complex regulatory environment; The regulator is also focused on increasing transparency
there is increased cost of regulatory compliance and low vis-a-vis direct plans to drive higher retail penetration.
tolerance for regulatory breaches
GST is expected to have a significant impact on the
B
est-practices in key global regulations that may impact mutual fund sector
the mutual fund regulatory regime in India

11 
AMFI data; Despite volatility, retail investors continue to take Mutual Fund route, The Financial Express, 27 April 2016

8 Mutual Funds: Ready for the next leap


Mutual Funds: Ready for the next leap 9
2. Global best
practices in asset
management
products

10 Mutual Funds: Ready for the next leap


Analysis of global AUM across traditional asset classes
Globally, mutual fund AUM has grown at a CAGR of 5.8% over the past five years, with the bulk of the increase driven by
12
equity and mixed/balanced funds. In 2015, global mutual fund assets increased slightly by 0.5% to US$32.2 trillion.

Global AUM (US$ trillion) across traditional mutual fund asset classes
24.3 23.6 27.0 30.3 32.0 32.2
7.1% 7.3% 6.9% 6.2% 6.0% 6.0%
12.4% 12.6% 12.7% 13.0% 13.2% 13.7%

19.2% 19.3% 17.6% 15.8% 15.3% 16.2%

22.1% 22.1% 21.1%


21.1% 22.9% 24.5%

40.3% 37.8% 38.2% 43.0% 43.3% 43.0%

2010 2011 2012 2013 2014 2015


Equity Bond Money market Mixed Others/guaranteed/real estate
Source: Strategic Insight/Simfund Global Dash Database

Global net ows (US$ billion) by fund type


1,400
1,200
1,000
800
600
400
200
0
-200 2009 2010 2011 2012 2013 2014 2015
-400
-600
-800
-1,000
All funds Equity
Bond Money market
Mixed
Source: Strategic Insight/Simfund Global Dash Database

In 2015, equity funds continued to dominate, with a 43% Notably, in 2015, money market management funds
share in global AUM. However, in recent years, the share witnessed the highest inflows among all asset classes mainly
of balanced/mixed funds, which invest in both equities and due to changes in the US market. Investors have shifted
fixed-income instruments, has increased slightly because their assets toward safe-haven funds, especially government
of the slowdown in net flows into equity funds after 2013 funds, in anticipation of the SECs new money market fund
caused by increased capital market volatility worldwide. regulations.

12
Strategic Insight/Simfund Global Dash Database

Mutual Funds: Ready for the next leap 11


During the past couple of decades, the mutual fund industry and Europe are the largest contributors to global mutual
has witnessed strong growth the world over. However, the fund AUM, with the Americas having the dominant share
amount, type and growth experience of mutual fund assets considering that the US is the largest open-fund market
has varied substantially across the four broad regions worldwide.
Americas, Europe, Asia-Pacific and Africa. The Americas

AUM distribution by region Allocation of AUM across regions by class (as of March 2016)
(as of March 2016) 0.8%
Africa 9.4%
14.7% 17.6% 21.1%
Asia and 0.3% 22.6%
Pacic 13.1%
10.2% 9.5%
12.4%
13.6% 17.0% 11.8%
23.0% 20.2%
Americas 7.5%
Europe
51.4% 22.0%
35.8% 10.5%
42.9%
24.8%

51.3% 2.3%
41.9% 43.9%
27.8%
20.4%

World Americas Europe Asia and Pacic Africa

Equity Bond Balanced/mixed


Money market Others
Source: ICI

Product preferences also vary significantly across regions share in the Asia-Pacific region. Strong fund flows in money-
and countries within a region. For instance, bond and mixed- market funds in Asia are driven mainly by Chinas on account
funds are more popular in European markets as sluggish of the high retail demand for online funds managed by large
growth, deflationary trends and geopolitical risks have led to domestic technology companies.
risk aversion. Equity and money-market funds hold a higher

Penetration of funds is low in Asian markets


Mutual fund penetration in most Asian economies hasnt kept pace with the growth in financial assets of the Asian
households and is relatively lower compared to American and European economies. As an investment option, mutual funds
13
constitute only ~10% of the Asian investors financial holdings.

Penetration of funds is much lower in Asia


AUM/GDP ratio (2015) Americas
114% Europe
91%
70% 63% Asia - Pacic
53% 51% 49%
38% 30%
11% 23% 11%
9% 7%

The US Canada Brazil Mexico France The UK Switzerland Germany Australia Japan China Korea India Taiwan

Sources: EFAMA, Oxford Economics

The mutual fund industry in emerging economies in Asia is characterized by low financial literacy levels, high churning of
funds and inconsistent advisory levels, leading to low product adoption. In western countries, such as the US, mutual funds
are seen as long-term savings tools and are also found in retirement options, while in Asia, investors view mutual funds
mainly as trading tools.

13
Cerulli: Ignorance about mutual funds widespread in Asia, LifeHealthPro, 14 October 2014

12 Mutual Funds: Ready for the next leap


Key trends serve to hedge an investors portfolio as certain sectors
move opposite to the economy. Moreover, investors
Rise of specialty products and investment solutions often follow a sector-rotation strategy by switching from
Globally, the asset management industry is also witnessing a one sector to another. Timely sector rotation increases
shift in net flows from traditional mutual funds to alternative the value of investment accounts and portfolios and
products such as specialist products and investment offers significant potential to grow wealth over time.
solutions. However, to successfully employ a sector-rotation
strategy, investors need to understand and follow the
Specialty funds: Specialty funds, which are commonly dynamics of each industry.
14

referred to as sector funds, invest a significant portion


(at least 25%) of their portfolio in a specific sector of the Other than sector funds, specialty funds may also include
economy, such as energy, financial services, technology international, regional or country funds and commodity
and real estate funds. These funds charge higher funds (such as oil funds, metal funds and funds based on
15
expenses and loads compared to diversified funds. While agricultural commodities):
these funds entail greater risks and volatility, they can

International funds Commodity funds


International funds include global diversified funds, The inability of small-ticket retail investors to directly
regional funds (focus on a specific geographical deal in commodities has driven the emergence of
region), country funds (focus on a single country) and commodity mutual funds, which invest mainly through
global sector funds (invest in a particular sector of the stocks of commodity companies. These funds do not
economy in various countries). However, such funds exactly replicate returns based on the underlying
expose investors to currency and country-specific commoditys prices, but are largely dependent on the
risks. For instance, funds that invest in Chinese equity underlying commodity. However, sector-specific risks
markets lost ~22% in one week in August 2015 due to are high for instance, energy mutual funds, which
high market volatility. In spite of increased volatility were the most popular funds in recent years, witnessed
in the markets, asset managers continue to focus on harsh losses in 2015 as a result of a combination of
China on account of growth opportunities, and more sliding oil prices and rising interest rates. American
than 830 China-focused mutual funds were launched investors had invested US$20 billion in energy funds
in 2015. in 2013 and 2014 and suffered losses of up to 35% in
certain cases in 2015. Energy funds dominated the
worst-performing US funds league table in 2015.

Investment solutions: Prior to the financial crisis, asset


managers mainly followed a product-push approach.
However, over the last decade, the focus shifted from
relative to absolute performance and now to investment
solutions, which focus on achieving a bespoke
investment return or income at some point in the future.
Success in the institutional client segment will require
a shift from selling products to creating solutions with
clients. The marketplace has already started increasingly
buying into customized solutions among which investors
can selectively choose from an array of services
designed around meeting their personalized goals.

14
 Specialty Funds vs. General Mutual Funds and Socially Responsible
Investment (SRI) Funds: An Intriguing Risk/Return Paradigm, Brian D.
Fitzpatrick, Joshua Church and Christopher H. Hasse, Rockhurst University,
Journal of Applied Business and Economics vol. 13(2) 2012
15
Beginners Guide to International Mutual Funds, 6 October 2014, http://
mutualfunds.com/international-and-global-stock-funds/beginners-guide-
to-international-mutual-funds/; Record number of China-focused mutual
funds launched, Financial Times, 10 January 2016; Mutual fund investors
burnt by energy in 2015, Financial Times, 27 December 2015

Mutual Funds: Ready for the next leap 13


Move to alternative products
16
Shift from traditional active funds to passives

Most actively managed funds underperform benchmarks post fees and trading costs, which has resulted in investors
looking at low-cost passive products as an alternative. According to S&P Dow Jones, 10 out of the 11 regions covered (for
both equities and bonds) failed to beat their benchmark over the past 10 years.

10 year selected global fund performance data (as of December 2015)

Region and risky asset Active managers Benchmark Difference


France equity 4.0% 4.7% (0.8%)
Germany equity 6.6% 7.4% (0.8%)
Italy equity 0.0% (0.9%) 0.9%
Spain equity 2.6% 2.9% (0.3%)
Netherland equity 3.1% 7.2% (4.1%)
U.S. equity 5.8% 7.4% (1.6%)
U.S. real estate 5.4% 7.3% (1.9%)
U.S. long-term government bonds 3.8% 6.7% (2.9%)
U.S. short-term government bonds 2.2% 2.5% (0.3%)
U.S. MBS 3.9% 4.6% (0.7%)
Emerging markets bonds 4.4% 6.7% (2.3%)
Source: SPIVA/S&P Dow Jones Indices/zerohedge.com analysis

Share of global asset management market Dissatisfied with underperforming active funds, which are
also perceived as overpriced, investors are increasingly
switching to passive investment funds, which track the
2009 11% 89% market and charge lower fees. As of December 2015,
~US$747 billion were moved into passively managed funds
and US$312 billion of actively managed funds were pulled
out by investors.
2015 19% 81%

Passive Active

Source: EY Analysis

16 
Active asset managers knocked by shift to passive strategies, Financial Times, 11 April 2016; Hello passive, goodbye active: fund investors make the switch,
Financial Times, 23 June 2013; Casey Quirk: Global AUM slumps in 2015; passive, ETFs take majority of flows, Pensions & Investments, 20 January 2016.

14 Mutual Funds: Ready for the next leap


Rise of liquid alternative mutual funds in the western Assets in liquid alternative mutual funds in the US
17
world doubled between 2011 and 2014. However, after 2014,
the asset management industrys efforts of bringing
During the past few years, a number of alternative
hedge fund strategies to the mass market stalled because
investment funds have been introduced in the American
of poor returns and investor skepticism.
and European mutual fund market because of industry
18
shifts and regulatory changes. Hedged mutual funds (also Stellar growth of exchange traded funds continues
known as alternative mutual funds) employ investment
Exchange traded funds (ETFs) are passively managed
tactics traditionally found in hedge funds such as
baskets of securities, which uniquely combine the
use of leverage, derivatives, and short selling vis--
benefits of stocks and mutual funds and are designed to
vis traditional mutual funds, which limit themselves to
closely track market indices. Their main advantages are
buying and holding assets typically stocks or bonds.
low cost, tax efficiency, liquidity, risk management and
These funds provide retail investors access to a diverse
transparency. ETFs continued to achieve market share
range of asset classes and investment strategies that
gains and witnessed record growth of over five-fold
were generally not available to them through regulated
over the past decade to US$2.9 trillion (as of December
vehicles earlier. They benefit investors by facilitating
2015), as investor concerns about overpriced and
access to a range of exclusive hedge fund strategies such
underperforming active funds fueled the demand for
as merger arbitrage, convertible arbitrage, long/short
passive funds.
equity and macro trading. In the US, these funds are
covered by the 1940 Securities Act, while in Europe they
are covered under UCTIS.

Global ETF AUM and their percentage to mutual funds AUM 9.8%
9.0%
8.1%
7.4%
6.5%
6.1%
5.2%
4.2%
3.5% 2.7 2.9
3.0%
2.3
1.9
1.4 1.5
1.1
0.6 0.8 0.7

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

ETF AUM (US$ trillion) ETF AUM as a percentage of mutual fund AUM

Source: Strategic Insight/MF and Global Dash Database

ETFs have been gradually gaining popularity over actively managed mutual funds. Their widespread acceptance by the crucial
Gen X and Gen Y market segment has emerged as a considerable threat to active asset managers in western economies.

Smart beta ETF strategies are one of the fastest growing The US is the worlds most successful ETF market,
trends in the ETF industry and have become increasingly distinguished by its size as well as liquidity and retail investor
popular for investors seeking to manage risk and factor base. ETFs have also become extremely popular in Europe,
diversification (i.e., low volatility, momentum, quality, value where the average annual growth rate of ETFs exceeded 40%
20
and size). According to BlackRock, smart beta ETF assets during the last decade. ETFs benefiting from low costs,
are expected to reach US$1 trillion globally by 2020 and high liquidity and transparent pricing became popular in
19
US$2.4 trillion by 2025. At the end of December 2015, the western economies against a backdrop of quantitative
smart beta ETFs assets totaled US$260 billion, representing easing by leading central banks. However, the penetration
10.1% of total ETF assets. of ETFs remains low in Asian markets vis--vis the US and
Europe. The advisory business in Asia is still commission-
based (as opposed to fee-based) and, therefore, advisors
21
have less incentive to recommend ETFs.

17 
Alternative or Hedged Mutual Funds: What Are They, How Do They Work, and Should You Invest?, Forbes, 28 February 2014; Liquid alternative mutual
funds leave investors disappointed, Financial Times, 23 May 2016
18 
Professionally managed Investment Solutions through Exchange Traded Funds, TOPS, 2013; Exchange traded funds grow bigger than hedge funds,
Financial Times, 21 July 2015
19 
BlackRock Projects Smart Beta ETF Assets Will Reach $1 Trillion Globally by 2020, and $2.4 Trillion by 2025, BusinessWire, 12 May 2016
20
European ETF Outlook, Lyxor ETF Research, February 2016
21
Could ETF takeup surge in Asia?, Fund Selector Asia, 31 August 2015

Mutual Funds: Ready for the next leap 15


Trends in global pension funds
O
verview of the global pension funds industry

According to a study by Tower Watson, pension assets in the 19 major markets increased at a CAGR of 5.3% over the last
decade to US$35.3 trillion in 2015. The US, the UK and Japan account for ~78% of total pension assets, with the US being
the largest market in terms of pension assets.

AUM* (in US$ trillion) Pension assets (US$ billion) in 2015 top 5 markets and India
%
: 5.3
15)
0520 35
R (20 21,779
CAG
21 3,204
2,746

1,523 1,484

94
2005 2015 The US The UK Japan Canada Australia India
Note: *Based on AUM of 19 major pension markets Source: Global Pension Assets Study 2016, Towers & Watson, February 2016

Asset diversification from equity to alternatives

Pension funds: asset allocation


5% 3% 1% 3% Asset diversification has gained
7% 9% 19%
24% momentum among pension funds
globally. Pension funds asset allocation
36% 38%
32% witnessed a shift from equities towards
29%
alternatives in order to escape market
volatility and increase returns. This
52% 50% 48% shift was also attributed to equities
44%
and bonds trading at high valuations
compared to their historic averages.
1996 2002 2008 2015

Equities Bonds Alternatives Cash


Source: Global Pension Assets Study 2016, Towers & Watson, February 2016

Shift in the retirement market from DB to DC plans Pension fund assets by scheme type
During the past decade, defined contribution (DC) assets
have grown at a CAGR of 7.1% while defined benefits
40% 42%
(DB) assets have grown at a CAGR of 3.4% in the top 48%
seven pension markets: Australia, Canada, Japan, the
Netherlands, Switzerland, the UK and the US. As a result,
DC assets share in total pension assets increased from
38% in 2003 to ~48% in 2015. DC plans dominated the 60% 58% 52%
22
pension markets in US and Australia.

2005 2010 2015


Dened benet Dened contribution
Source: Global Pension Assets Study 2016, Towers & Watson, Feb 2016

22 
Global Pension Assets Study 2016, Towers & Watson, February 2016; Global pension fund assets hit record high in 2013, TowerWatson, 5 February 2014

16 Mutual Funds: Ready for the next leap


The increasing share of DC plans vis--vis DB plans places I ncreasing demand for investment solutions in
a significant retirement savings burden on employees. One pensions
of the main drawbacks of the shift away from DB pension
The pensions markets is witnessing increasing demand
plans for investors is that retirees will no longer have
for investment solutions in the growing usage of liability-
a guaranteed income stream they will have to create 25
driven investing (LDI) and target-date funds.
one from their DC plan and other savings. This opens up
opportunities for asset managers to create new products
for the decumulation phase i.e., the part of the pension LDI
life-cycle when individuals start to withdraw from their
savings. As a result, there is a growing focus on the need for Pension plan sponsors are adopting liability-driven
more innovative products that meet the needs of pension investing (LDI) strategies which reduce the asset-
members. Fund managers have begun to release new liability mismatch to reduce the volatility in their
investments products or are revamping existing products plans funded status. This generally means a shift out
that focus on the needs of retirees. of equities and into fixed income investments that
better track the value of a plans liabilities. LDI is a
One new major innovation within the pension landscape is
more methodical way for pension plans to stabilize
the introduction of collective defined contribution (CDC)
their funding status throughout market cycles
pension schemes, which are also known as shared risk
compared to traditional pension investing. It is more
or defined ambition schemes. Unlike DC savers, which
prevalent among pension funds in Europe than the US.
build up their individual account, under defined ambition,
According to estimates of consultancy firm Spence
everyones money is aggregated into a single pool,
Johnson, a third of all UK-defined benefit assets are
reducing investment uncertainty and providing economies
currently invested in LDI mandates, and it predicts that
of scale. Income is paid directly from the savings fund.
the demand for LDI will account for 40% of DB pension
CDCs are offered in the workplace, where both employers
assets by 2024.
and employees make contributions. Under the collective
model, all members share the ups and downs of investment
performance, and market shocks are absorbed by the group
23
fund, which reduces the impact on any individual member Target-date funds
Target-date funds are the main default-option funds
Case study: in most DC plans in the US. Target date funds have
CDC pension schemes proposed for the emerged as the investment of choice for 401(k) plan
24
UK in 2014 (DC) sponsors and participants. According to Cerulli
Associates estimates, target-date funds will continue
CDCs, which involve members paying into a joint fund to grab more 401(k) assets, capturing 88% of new
and sharing earnings, were proposed by the UKs contributions to the plans, and will represent 34.6% of
former pension minister in 2014. The Government the total 401(k) assets by the end of 2019, reaching
considered CDCs to offer better pensions to people US$2 trillion in AUM. These funds are also likely to gain
saving for their retirement. Most people in the UK are popularity in Europe as well. For instance, in the UK,
either members of a final pension scheme provided the Trustee of the National Employment Savings Trust
by employers or a defined contribution scheme, (NEST) pension scheme has set target-date funds as
which may be employer-sponsored or private. The the default option for its members.
introduction of collective pension schemes, which
are already operating in other countries such as the
Netherlands and Canada, could facilitate more stable
retirement income.

23 
What are proposed collective pension plans?, Financial Times, 4 June 2014
24 
What are proposed collective pension plans?, Financial Times, 4 June 2014; UK government criticized for shelving group DC pensions, The Actuary, 16
October 2015; Retreat from CDC strategic, tactical, says UKs Altmann, Investment & Pensions Europe, 16 October 2015
25 
Pension survey shows fierce competition for assets, Financial Times, 22 November 2015; Cerulli: Target-date funds snagging larger share of 401(k)
assets, Pensions & Investments, 24 November 2014

Mutual Funds: Ready for the next leap 17


3.
Products:
Indian Scenario

18 Mutual Funds: Ready for the next leap


Debt funds constitute significant share of industry AUM
Unlike global AUM mix where equity is the dominant asset class, in India debt (or income-oriented) schemes continue to
dominate accounting for almost half of the industrys AUM. However, post 2013, increased demand for equity and money-
market funds has led to decline in the share of debt funds in overall AUM mix.

AUM across asset classes

2.6% 2.9% 2.8% 2.4% 2.0% 2.4% 3.2%


12.3% 12.5% 13.6% 13.3% 16.2% 15.0% 16.2%

32.5% 24.6% 23.2%


33.1% 31.0% 31.9%
31.3%

56.5% 55.9%
51.1% 49.3% 49.5% 47.7% 46.0%

Mar'10 Mar'11 Mar'12 Mar'13 Mar'14 Mar'15 Mar'16

Debt Equity Money Market Balanced ETFs Gilt Fund of Funds


Source: AMFI

Key drivers of recent surge in mutual fund AUM:


Indian Mutual Fund Industry Assets Under Management (INR trillion) Mutual fund AUM has witnessed
a steady rise since Mar12
12.3
10.8 and more than doubled to
8.3 INR12.3t as of Mar16 driven by
6.1 7.0
6.0 5.9
improved market sentiment as
well as initiatives to channelize
household savings into MFs
Mar'10 Mar'11 Mar'12 Mar'13 Mar'14 Mar'15 Mar'16
vis--vis traditional investment
avenues such as gold.
Source: AMFI

Equity funds have witnessed significant inflows in recent years: In FY15 and FY16, equity funds witnessed a surge in
AUM in line with the revival in Indian capital markets. In 2015, equity mutual fund assets crossed the INR4 trillion landmark
for the first time in mutual fund history mainly driven by increased demand by retail investors, especially investors from small
towns, as they took to investing in the mutual fund market with sluggish growth in the real estate space and decline in gold
26
prices. During FY16, MFs reported net inflows of more than INR750b in equity and equity-linked savings schemes with
27
investors from smaller towns contributing for 44% of these flows.

26 
Mutual fund industrys asset base surges 21% to Rs 13.4 lakh cr in 2015, The Financial Express 3 January 2016
27
Assets under management of mutual funds grow 14% in FY16, International Business Times, 4 April 2016

Mutual Funds: Ready for the next leap 19


Regulatory initiatives related to mutual F
und houses are focusing on new types of product
offerings
fund products
Recently, fund houses have started approaching SEBI
SEBI to drive fund houses to rationalize product
28 with proposals for new fund offers in line with increased
offerings
retail investor demand. As of June 2016, mutual fund
India has more than 2,100 mutual fund schemes in the two houses had filed draft applications with SEBI for ~50 new
primary asset classes: debt and equity. Such a large number fund offers, including hybrid, equity, debt, retirement,
of products lead to confusion and misinterpretation. Hence, fixed maturity plans (FMPs), tax-free bonds and speciality
30
there is a need for fund houses to consolidate mutual fund funds. Many fund houses are also moving away from
schemes with similar objectives to facilitate better investor the traditional English names for plans and launching
understanding. SEBI is pushing for fund houses to rationalize plans with vernacular names in order to facilitate better
their product portfolios. This is reflected in the decline in the understanding of mutual funds in rural areas.
issuance of new fund offers (NFOs).
Other new types of investment products:
Trend in NFO issuance
Real-estate Investment Trusts
Category FY13 FY14 FY15 1HFY16
Real estate has traditionally been a highly preferred asset
Balanced 17 1 1
class among Indian investors. However, with the possession
Debt 798 947 916 261 in a number of new property launches getting delayed in
Dynamic/asset allocation 28 28 42 29 the past few years, investors have become vary of investing
Equity 220 21 80 38 directly in real estate. The alternative used in developed
market is Real-estate Investment Trusts (REITs). REITs
ETF 2 5 6 8
originated in the US and have been successful in several
FoF 32 3 2 1
countries such as Singapore, Australia and Hong Kong.
Gilt 36 2 3 REITs allow investors the opportunity to invest in income-
Liquid 18 16 generating real estate assets, which could range from
Specialty 17 2 offices to residential apartments and shopping centers.
REITs are structured as trusts, which are listed on stock
Total 1,168 1,023 1,059 340
exchanges, and investors buy units in the trust. Typically,
Source: Indian Mutual Fund Industry: The Road Ahead, Assocham Report,
November 2015
the trusts distribute 90% of their income among investors
by issuing dividends, usually generated from rental income
Reduction in expense ratio toward global norms and capital gains from the profitable sale of real estate
India has one of the highest expense ratios for equity and assets. In India, a minimum investment of INR200,000
31
allocation funds: averaging over 2% of asset-weighted is required in a REIT. Recently, SEBI relaxed the norms
expenses for allocation funds, compared to between 1% and for REITs allowing them to invest a larger portion of
29
1.7% for most countries. SEBI has issued many regulations their funds (up to 20% from the current level of 10%) in
in the mutual fund sector regarding the launch of mutual assets under construction and also proposed changes
fund schemes as well as advertisement codes to ensure to facilitate easier entry for offshore fund managers.
investor protection. The regulator has also capped the TER Moreover, the Government has also decided to remove
32
of fund houses: the maximum TER that an equity scheme dividend distribution tax (DDT) on REITs. With the recent
can charge is 2.5% (2.25% for debt schemes) for the first support from regulators and the Government, REITs may
INR1 billion in weekly average net assets of a scheme, gain popularity going forward. According to Cushman and
2.25% for the next INR3 billion and 1.75% for anything Wakefield, Indian commercial real estate offers investment
beyond, with a relaxation of up to 30bps depending on opportunities for REITs worth INR2.8 trillionINR3.6 trillion
the proportion of fund flow from beyond the top 15 cities. in the top cities. REITs provide retail investors a regulated
Lowering of TER by the regulator could prove to be a and transparent mechanism to participate in the real estate
facilitator for drawing more small investors to the mutual sector, which has so far been dominated by HNI/institutional
fund market. SEBI has adopted a stringent approach toward investors. Some of the advantages of REITs as an
new fund launches, as many small investors faced losses investment avenue vis--vis physical real estate are higher
because they misunderstood the market risk involved in liquidity, lower brokerage, no long-term capital gains tax
several mutual fund products. and no stamp duty. Moreover, REITs provide diversification
benefits. However, they are subject to volatility and
investment risk.
28
 A to-do list for mutual funds in 2016, Mint, 19 August 2016; Indian Mutual Fund Industry: The Road Ahead, Assocham Report, November 2015; New
equity mutual fund launches dip 70% in 2016, Business Standard, 9 June 2016
29 
Sebi looking to lower expense charges for mutual fund, Mint, 22 January 2016
30 
Mutual Funds approach Sebi with 50 new proposals in 2016, The Financial Express, 26 June 2016
31 
Nuts and bolts of Real Estate Investment Trust, The Hindu, 12 June 2016; Six reasons why REITs will be a boon for real estate investors, Moneycontrol
32 
Sebi relaxes norms for REITs, eases entry of offshore fund managers, The Indian Express, 18 June 2016; Exemption of dividend distribution tax: REITs now
a step closer to reality, The Indian Express, 5 March 2016

20 Mutual Funds: Ready for the next leap


Alternative Investment Funds (AIFs)
Alternative Investment Funds (AIFs) are investment vehicles established to pool in funds for investing in real estate,
private equity and hedge funds with a pre-determined objective. AIFs are primarily aimed at high net worth individuals
(HNIs) with minimum individual investment of INR10 million as per SEBI norms. There are three categories of AIFs
Category I: funds that get incentives from the Government or regulators and include venture funds, social venture funds
and infrastructure funds; Category II: funds that do not get concessions and cannot raise debt for investment purposes
(only day-to-day operations) and include private equity funds and debt funds; and Category III: funds that are traded to
make short-term returns and include hedge funds.

AIF category-wise commitments, fund raised and investments (INR billion)


504.4
62.5

327.0 260.0
48.5 206.7
38.2
Category I
167.3
137.8 Category II
115.0 Category III
44.1 30.7
Commitments raised Funds raised Investments made
Source: SEBI (Cumulative net gures as of 30 June 2016)

Funds collected for AIFs from HNIs are primarily invested in unlisted securities and start-ups to promote entrepreneurship.
SEBI is also planning to create a new category of AIFs to encourage long-term funds to flow the AIF route. SEBI may reclassify
Category III AIFs into one group of long-term funds such as pensions and another group of short-term arbitrage funds such as
33
hedge funds.

M
uted investor response to popular global products, such as ETFs
34
Contribution of ETFs picking-up but still minimal

ETFs AUM (INR billion)


2.0%
1.9%
1.8%
1.6%
1.4%
1.2% 160.6
14.8
16.1 45.3 80.6

0.4% 25.2 116.5


98.9
86.8
9.6 66.5 63.5
44.0
15.9
Mar'10 Mar'11 Mar'12 Mar'13 Mar'14 Mar'15 Mar'16
Gold ETF ETFs (other than Gold) ETFs share in total AUM
Source: AMFI
ETFs, which are in high demand in developed markets, are yet to gain popularity with Indian investors. As of December 2015,
there were 1,577 ETFs traded on the NYSE, 1,109 listed on Deutsche Brse and 2,315 on London SE, while only 54 traded
on the National Stock Exchange. Globally ETFs share in mutual fund AUM is 9.8%, while in India it remains low at 1.8%.

33 
Sebi registers over 200 Alternative Investment Funds, DNA, 20 April 2016; Foreign inflow boost for alternative investment funds, Business Standard, 22
November 2015; De-jargoned: Alternative investment funds, Mint, 4 March 2015; Alternative Investment Funds coming to India? Heres what you need to
know, The Financial Express, 13 July 2016; Sebi panel suggests reforms to grow alternative funds industry, Mint, 21 January 2016
34
Gold ETFs Lose Shine for Indian Investors, The Wall Street Journal, 20 January 2014

Mutual Funds: Ready for the next leap 21


The ETFs listed on Indian exchanges are typically based P
ension fund sector in India
on equity indices (local or international), gold or debt. 37
Awareness of ETFs in India is very low and restricted mainly Current state of the pension fund sector in India
to gold ETFs. Gold ETFs dominated the ETF market in India Indias pension business has immense potential to grow,
till 2014. However, since then, gold ETFs have lost favor with as the current state of the pension fund sector in India
investors due to a fall in international gold prices. is marked by insufficient pension coverage and a large
Another reasons that ETFs have not gained popularity is unorganized sector workforce. Only 9%10% of the
38
that distributors have less incentive to market them given population is covered by some type of pension benefits.
that they are low-margin passive products. In the US, ETFs
grew in popularity once the commission on mutual fund
distribution was removed and distributors moved to a fee- Indias pension system
based model. The differential commission structure between The pension system in developed markets including India is
mutual funds and ETFs is a crucial reason for the low based on a three-pillar structure:
penetration of ETFs in India.
India lacks a robust pillar
ETFs may gain popularity going forward one system, as there is
ETFs are likely to be one of the products to drive significant no social security system;
Funded by
growth in the Indian asset management industry. Recently, Pillar one instead, there are a
Government
the Employee Provident Fund Organization (EPFO), which number of social assistance
is Indias largest government-sponsored employee pension programs for economically
fund, decided to allocate 5%15% of its corpus in equity backward classes.
investing in line with the Governments drive to inculcate
a long-term equity investing culture among domestic This system is well-
investors. EPFOs initial choice for equity investing was established mainly on
ETFs based on Sensex and Nifty, and it invested INR32 account of legislation on
Sponsored by
Pillar two gratuity and Provident
billion between August 2015 and December 2015 in these employers
ETFs. A push from the Government has started giving ETFs Fund (PF); schemes include
visibility with retail investors. Non-gold ETF AUM almost central civil service pension
doubled from INR80.6 billion in March 2015 to INR160.6 and employees PF.
35
billion in March 2016. Currently, the Indian equity market
Pillar three is still at a
offers significant stock-picking opportunities for active fund
nascent stage. It includes
managers. Certain mutual funds have recorded returns that
36 insurance products, mutual
are significantly higher than benchmarks. With increasing
Sponsored by funds, Public Provident
maturity in the Indian markets, it will become more difficult Pillar three
employers Fund, National Pension
for fund managers to outperform indices, leading the way
System (NPS) and any
for passive investing or index tracking. In the US, in the
other personal savings for
last 20 years, approximately 65%-80% of fund managers
retirement.
have under-performed the S&P 500. An increase in
investor awareness regarding ETFs and higher liquidity and
transparency in the ETF market are necessary to fuel the Some of the most popular retirement benefit schemes in
growth of the ETF industry in India. India include the Employee Provident Fund, Public Provident
Fund and, most recently, the National Pension System. The
Employee Provident Fund, which is a defined contribution
plan managed by the EPFO, is the principal source of
retirement planning for workforce in Indias organized sector.
The Government of India launched the National Pension
System (NPS), a defined contribution scheme, in January
2004 to provide retirement income to citizens. Initially,
it was introduced for new government recruits but was
later extended to all citizens, including unorganized-sector
employees, on a voluntary basis. The Public Provident Fund
is a defined contribution scheme with an administered rate
of return, offered to individual investors without restrictions.
The benefits include total accumulations that can be
withdrawn after 15 years of service.
35

Why 2016 looks so promising for the Indian equity market, The Economic Times, 25 December 2015; AMFI
36
Why India is not an ETF market, MorningStar, 21 March 2016
37 
Pension business in India, EY Report, November 2013; Global Pension Assets Study 2016, Tower Watson, February 2016
38 
Only 9 per cent covered under pension in India, Indian Express, 20 July 2016

22 Mutual Funds: Ready for the next leap


Pension coverage needs to improve support the funding of long-term infrastructure projects.
The Government is working toward bringing the informal
According to the PFRDA, only 9%10% of the total Indian sector workforce (88% of the total workforce) under a
population is covered under pension benefits, while a formal retirement fund through schemes such as NPS and
majority of the informal workforce remains devoid of Atal Pension Yojana. The Government is also directing
retirement benefits. Only ~3%4% of informal sector banks to increase coverage under the Atal Pension
39
employees have pension coverage. The benefits of Scheme, which is a defined benefit scheme targeted at
government schemes such as PPF and EPF, which are used the unorganized sector, by tapping channels such as
to accumulate a retirement corpus, are not mandatorily in business correspondents, aggregators and microfinance
the form of a retirement income. Hence, there is a need for 41
institutions. Moreover, the pensions regulator PFRA
products specifically aimed at providing a steady stream of has started implementing a standalone foreign direct
40
income after retirement. Insurance companies and mutual investment policy for the sector in order to de-link pension
funds have recently started launching retirement plans. from the insurance sector, chart out a separate roadmap
However, this is leading to product arbitrage on account for its growth and encourage foreign investments in the
of variation in charges levied on customers and incentives 42
sector. Recently, a number of domestic pension funds have
given to distributors. started investing in the stock market. In 2015, EPFO, which
The development of pension funds is critical to Indias manages over INR8.5 trillion worth of funds for salaried
economic growth as pension funds not only provide employees, started investing in stocks (5% of its incremental
financial independence to the elderly population, but also inflows) for the first time in its 64-year history.

According to EY estimates, the estimated size of the retirement fund corpus in 2025
across different market segments is estimated to be as follows:

Estimated market size of different segments (INR Billion)


Public Provident Fund 2,325
Life insurance/Annuity 28,193
EPFO 38,572
Private pension (BSE Top 100)* 12,428
National Pension Scheme 1,880
Total estimated size of corpus @ 2025 83,398
Source: Pension business in India, EY Report, November 2013

39

Govt. working towards bringing informal sector under pension scheme, says Chairman, PFRDA, FICCI, 9 December 2015
40
Need for deeper pension coverage, Mint, 2 January 2016
41
Increase coverage under Atal pension scheme: Govt tells public sector banks, DNA, 12 June 2016
42
Dedicated FDI policy to chart new course for pension sector, Business Line, 12 April 2016

Mutual Funds: Ready for the next leap 23


4.

Digital:
Key global WAM
trends in digital
24 Mutual Funds: Ready for the next leap
Successful digital transformation requires asset managers to transform all aspects of their
business

Increase sales through Increase customer loyalty


more granular marketing and sales conversion
efforts (e.g., location or
Migrate customers to
microsegment based)
low-cost channels

Increase customer loyalty Digital Customer


experience Increase sales through
through value-added services sales and
marketing and improved lead generation
Increase revenue through Digital channels
Big data Reduce risk costs through
digital-enabled products product and
service and granular risk evaluation
innovation analytics
ness value
usi
Increase staff
Reduce costs through
effectiveness and
efciency through Internal
ita l r Digital automation and avoidance
of rework

ive
collaboration platforms collaboration operations
Dig

and BPM

rs
Improve customer
Increase sales through Scope of experience through
mobility tools, e.g.,
reduced lead times
sales apps on tablet
transformation and errors

Dene the role of each Technology


Digital and enabling Put in place IT architecture
channel by segment strategy capabilities and infrastructure to
Develop road map Ena l e rs enable digital front-end
of investments
Digital People and Put in place middleware,
program organizational APIs, web services to
Rigorously control management Digital risk change
management enable agile front end
program execution and development
Track investments cybersecurity
and impact Develop digital talent
acquisition plan
Manage conduct risk Redesign organization
associated with digital structure to enable
Develop cyberattack digitization
management plan

Source: It got so late so soon; Wealth and asset managers awake to new digital age, EY, 2015

Rise of direct to consumer (D2C) Digital is empowering customers as well as changing the
rules of engagement for asset managers
distribution
Technology is enabling platform convergence and creating
The use of digital touch points by financial services
opportunities for new client engagement.There is an
customers has greatly increased in the last few years,
increasing number of online trading, brokerage, investment,
especially in evaluation and purchase. Investor expectations
direct-to-consumer (D2C) and robo-advisors offering user
are shifting customers now demand personalized services,
friendly, low-cost, automated solutions for core functions
and expect them through their channel of preference and at
such as investing, asset allocation, portfolio management
their choice of time and location. New digital access points
and reporting. Technological developments are creating new
are allowing customers to research and purchase across
playing fields throughout the fund-distribution value chain.
multiple channels, including online and mobile. The typical
purchase cycle now involves touch points across many
channels both digital and analog. The emergence of digital
is forcing asset managers to invest in front-office digital
capabilities.

Mutual Funds: Ready for the next leap 25


Financial institutions value chain models and evolution

Past: Linear relationship

Financial services producer Distributor Clients

Present: Disintermediation & multiplication of distributors

Historical distributor
Customer
Financial services producer experience provider Clients
New models of (disintermediation)
distributionNet
work mediation

Future: Roles are converging and interconnecting, creating new client engagement opportunities

Disintermediation direct to consumer

Historical distributor
Customer
Financial Data provider, experience
services customer New models of provider Clients
producer knowledge D2C distribution/network (disintermediation)
mediation

New customer roles

Source: Digital disruption and the game-changing role of technology in global wealth management IT in wealth management 2015 ,
February 2015; EY: The changing face of advice, July 2015; EY Analysis

A direct distribution strategy helps asset managers create closer relationships with and get a better understanding of the end
consumer, which in turn helps in the product-development process. Asset managers can build an effective D2C distribution
strategy by:

Steps for an asset manager to build an effective D2C distribution strategy


Branding: A prerequisite of this strategy is a strong consumer brand. A handful of large asset managers (particularly those
headquartered in the US) are increasing their investment on their brand and marketing. There is a shift happening from
marketing products towards building brand awareness and positioning.

Creating a consistent omni-channel client experience: Regardless of the number of products, services, touch points,
customers need to feel like they are dealing with one firm across multiple channels that they now use to interact with firms.

Leveraging the power of social media: Information shared through social media often has an exceptionally quick impact on
brand perceptions and purchasing decisions. Fund firms need to use social media to engage and interact with clients rather
than simply disseminating content.

Reducing product proliferation which will not only remove some costs from the systems but also help to simplify the choice
for the consumer and to reduce the noise created by underperforming products.

Establishing robust controls and processes to deliver on the requirements of regulations such as KYC and AML, which they
have previously been shielded from by the intermediaries. These requirements pose significant challenge to distribution given
the jurisdictional variations in their application and often fragmented and inadequate sources of data for due diligence.

26 Mutual Funds: Ready for the next leap


Digital technology is helping asset managers revamp their business models through
standardization, centralization and outsourcing of operations
Primary drivers of changes in asset managers' operating model

55%
45% 42%
30%

15% Asset managers are driving


10% growth by globalizing their
businesses, enhancing
Improving Enabling Changing Targetting Increasing Differentiation distribution channels, offering
distribution new regulatory new brand through new products and entering
channels products landscape geographic/ awareness increased new markets. As a result, the
demographic value/ number of locations, trading
markets lower cost
volume and product complexity
Source: Managing complexity and change in a new landscape, EY Survey, 2014 continue to increase.

Fund houses need to effectively standardize and centralize operations and also outsource in order to improve consistency,
reduce costs and enhance control. Digital technology is a key driver of standardization, centralization and effective
43
outsourcing:

Standardization Centralization
A common technology platform and data architecture Asset managers can centralize core business functions,
helps in standardizing the investment manufacturing not only in the middle- and back-office (e.g., trade
and administration processes. Fund houses are processing, corporate actions and reconciliations), but
rationalizing the number of applications and replacing also further up the value chain in investment research
legacy patchwork of applications with the best breeds and portfolio management, by creating centers
of PM/OMS/EMS* platforms for each major asset of excellence in near-shore or off-shore locations.
class. They are shifting away from custom developed Notably, larger asset management firms are more likely
or customized third-party solutions to out-of-the-box to maximize near-shoring and off-shoring strategies.
vendor capabilities that offer integrated PM, OMS and
EMS solutions. In the front-office, for instance, where Asset managers' target location strategy for
large firms have historically supported two, three in-house operations activities
or more platforms based on asset type, the drive is
to consolidate to a single core application for order
8%
management, execution, processing and investment
record keeping (IBOR). According to Ovum forecasts,
17%
technology spend in asset management is expected to
grow at a CAGR of 5.1% between 2014 and 2018.
55%
20%
Outsourcing
Increased focus on core strengths will further drive
outsourcing of all non-core activities to third-party
service organizations. Firms will look to consolidate Maximize use of nearshore locations
their outsourcing arrangements with one or two Maximize use of offshore locations
strategic partners, and as these strategic partnerships Limited or no nearshoring or offshoring
Dont know /uncertain
mature, asset managers will use them to provide
more support in client-facing processes, including Source: Managing complexity and change in a new landscape,
EY Survey, 2014
distribution and client reporting.
While many asset managers currently prefer the
proximity and time zone characteristics of near-shore
43 
locations, ultimately they may move to an off-shore

Ovum says increase in financial markets IT spending points to end of credit model, leveraging lower cost centers and maximizing
crunch, Ovum, 19 March 2014, http://www.ovum.com/press_releases/
ovum-says-increase-in-financial-markets-it-spending-points-to-end-of-credit- the use of the 24-hour clock (e.g., India and Malaysia).
crunch/*PM/OMS/EMS Project Management, Operations Management,
Enterprise Management

Mutual Funds: Ready for the next leap 27


Deploying and maintaining leading business applications are the top technology priorities
for asset managers
With increasing focus on standardization and centralization using digital technology to support the scale and scope of global
operations, asset managers are prioritizing the deployment and effective management of the right business applications,
and the creation of the data management infrastructure needed to do so. Firms require flexible and scalable technology
that supports a number of objectives across the enterprise, such as supporting a global footprint, new client onboarding,
supporting new products, maintaining efficiency throughout the trade life cycle, meeting regulatory requirements, improving
customer service through digital technologies or managing enterprise risk by providing a consolidated and granular view of
the entire enterprise.

Asset Managers' top technology priorities

Establishing and maintaining infrastructure


with leading business apps 50%

Quality/Timeliness/Reliability
of data across enterprise 45%

Reducing cost/Increasing
28%
efciency of service

Enabling global footprint


for multi-region support 18%

Integrating data to support new


18%
tools demanded by investors

Enabling new technology while


15%
maintaining information security standards

Source: Managing complexity and change in a new landscape Global survey on asset management investment operations, EY, 2014

28 Mutual Funds: Ready for the next leap


44
Digital technologies transforming and shaping the future of the asset management sector
In the space of less than a decade, the financial services sector has started to emulate the technology-driven operations of
digital bellwethers with new innovations spreading from transactional back-offices to web-based front-ends. Asset managers
have traditionally been the financial industrys late technology adopters. However, in the past couple of years, digital has
started transforming the asset management space rapidly. New investments in digital technologies can help asset managers
engage more effectively with clients at every touchpoint in the client experience life cycle.

Mobile Social media


Clients are increasingly demanding seamless, ocial media has become a crucial element in asset
coordinated and easy digital access to their providers. managers marketing strategies. Given its scalability
The coming-of-age millennial generation expects and efficiency, tactical use of social media can reduce
everything to be possible on their smart devices, which spending on advertising and promotion. Rather than
provide ubiquitous access to a deep array of anywhere, flying across time zones for television interviews, for
anytime online and mobile transactions. They want instance, executives can host a social media chat and
the same level of technology sophistication from their reach a wider audience. In April 2013, the SEC ruled
financial advisors that they see from incumbent tech that social media is an acceptable venue for companies
firms. Hence, digital client experience is expected to disclose information to investors. Social media
to play a crucial role for asset managers and mobile platforms enable exclusive, specialized access to peer
devices will be key in facilitating this experience. Mobile groups to share investment information and other
devices act as digitally enhanced portable work stations shared interests either through proprietary tools or
and help asset managers build intimacy and develop existing channels.
closer relationships with clients. Advisors can also free
up a significant portion of their time by leveraging Inuence of Social Media on product offerings
online chats and video-enabled conferences to interact and distribution strategies within next ve years
digitally.

Big data and analytics 17%

Predictive analytics, which provides a statistical


analysis of investor actions and the likelihood of future 20%
purchases, is expected to be a crucial driver of change 63%
in asset managers distribution strategies and product
offerings. In a survey of 125 asset management
professionals, 43% nominated big-data analytics
where large sets of information are analyzed to
Inuential
uncover market trends or other useful information as
Dependent on adoption by intermediaries
the technology that will have the most impact on the
45
fund industry. Moreover, in a study conducted by the No inuence
Economist Intelligence Unit, 85% of the asset managers Source: EY Global regulated funds survey 2014
said their organizations captured value from data only
46
fairly or somewhat well. Hence, the majority of Asset managers expect social media to have a
asset managers are expected to invest more in data significant influence on their product offerings and
analytics in the next two to three years. Going forward, distribution strategies. It helps in not only developing
firms should invest in the visualization of data analytics brand and product awareness, but also increasing
to deliver virtual portfolios in a fluid, visual and intuitive investor awareness and interacting more directly with
way via secure online channels. customers.

44
It got so late so soon; Wealth and asset managers awake to new digital age, EY, 2015
45
Blockchain could be totally transformative for fund industry, Financial Times, 22 May 2016
46
Fund managers to increase spend on data analytics, Bloomberg, 27 April 2016

Mutual Funds: Ready for the next leap 29


Cloud-computing FinTech
Cloud computing is revolutionizing the asset The asset management industry, similar to other
management business by facilitating unprecedented financial services sectors, has witnessed the rise of
business agility, flexibility and scalability at a low total FinTech firms, i.e., start-up firms providing alternatives
cost of ownership (TCO). Cloud technology is being to traditional business models. These firms are looking
rapidly adopted across front-, mid- and back-office as to provide services at a fraction of the incumbent
the preferred software delivery model. According to an prices. They have captured the opportunity that smart
industry report, more than 71% of asset management devices have provided by lowering the barriers to
firms intend to adopt cloud or increase its usage by entry, capitalized on consumers lack of trust for some
47
2017. incumbents, understood the appeal of flat-fee pricing
and the unbundling of advice from management, and
ridden a wave of powerful investment to arrive quickly
on the scene. According to a report from International
and CB Insights, global investment in FinTech
48
companies reached US$19.1 billion in 2015.

Robo-advisors
Robo-advisors, an automated low cost alternative to traditional financial advice providers, have gained popularity
recently.

Sectors most affected by automated According to a survey by the CFA Institute, 54% of the
nancial advice tools respondents around the world viewed asset management
2% as the financial services sector most at risk from
disruption by automated financial advice tools.
7%
Robo-advisors offer user-friendly digital platforms and
8%
conduct individualized risk profiling via algorithms to
determine an optimal asset allocation for an investors
12%
portfolio. They use a combination of simplified client
54%
experience, lower fees and increased transparency
16% to offer automated advice directly to consumers. The
mass-affluent segment is expected to benefit the most
from lower costs and increased access to investing
guidance. According to a CFA Institute survey, 34% of
Asset Management Banking Securities the respondents believed that automated advice could
Insurance Others None of the above entirely replace human advisors in the mass-affluent
49
Source: Robots Will Strike Asset Management Firms First, segment. Notably, in the US, the D2C robo-advisor
Bloomberg, 3 May 2016 market is increasingly becoming a fixture in the asset
management space. According to research by Cerulli
According to a survey by the CFA Institute, 54% of the
Associates, robo-advisors in the US will manage US$489
respondents around the world viewed asset management
billion by 2020, fueled by a shift of assets from traditional
as the financial services sector most at risk from 50
advisors to automated investment. Further evolution of
disruption by automated financial advice tools.
robo-advisors would require incorporating a broader set
of investment options and products.

47
 The Cloud makes some changes in the asset management industry, //www.bisam.com/our-
48
insights/cloud-makes-some-changes-asset-management-industry, 23 March 2014
Fintech Will Change the Way You Invest, US News, 25 April 2016
49
Robots Will Strike Asset Management Firms First, Bloomberg, 3 May 2016
50
The rise and rise of robo-advisers, Financial News, 30 March 2016

30 Mutual Funds: Ready for the next leap


Block chain
Asset managers believe that block chain can cause substantial disruption in their business models. Block chain, which
is a giant online public ledger developed keep track of bitcoin transactions and recently, recently found use in the fund
industry. Many asset managers believe that block chain could eradicate the need for clearing and settlement, which,
in turn, will reduce the staff requirement for some roles and lower the fees for investors. In a survey of 125 asset
51
managers, 42% listed block chain to be the biggest disruptive force within the fund industry.

52
Case study: the UKs largest fund houses are testing block chain to save trading costs
Five of the UKs largest mutual fund companies have teamed up to work on a project to test whether block chain
technology can be used to rationalize trading costs. This is the first instance of asset managers testing block chain.
These UK fund houses collectively manage more than 1 trillion in assets and are investigating several uses of
block chain, such as trading illiquid securities directly and facilitating quick movement from one asset manager to
another a process that currently takes several days. If these uses are successfully implemented, asset managers
can substantially rationalize costs by cutting out the need for intermediaries such as banks. Fund houses have lagged
behind in exploring potential uses of block chain, mainly because any system failure could lead to huge reputational
risks.

51
Blockchain could be totally transformative for fund industry, Financial Times, 22 May 2016.
52 
Five UK fund houses explore blockchain technology, Financial Times, 6 February 2016; Five UK Mutual Fund Companies Consider Using Blockchain for
Trading Assets, Coinspeaker.com, 10 February 2016

Mutual Funds: Ready for the next leap 31


5. Digital:
Indian scenario

32 Mutual Funds: Ready for the next leap


Technological advances are transforming of mobile and online apps for tracking and transacting
53
portfolios, as well as for effective distribution and customer
Indias mutual fund industry
service. AMCs are using social media to reach out to
Technologies such as mobile, social media, big data and customers, especially new-age customers, and employing
analytics, cloud and artificial intelligence are transforming big data and analytics in data-driven models for improving
the mutual fund industry and continue to be a key growth offerings and customer engagement while using cloud
enabler by facilitating seamless customer acquisition and technologies to drive process efficiencies and rationalize
real-time efficient processes. Technology has become a costs. The advent of artificial intelligence is also causing
crucial element across mutual fund operations spanning significant disruptions in the asset management sector,
from transaction processing and fund management to with robo-advisors threatening the traditional advisor
distribution and customer service. Asset managers are model. Additionally, the launch of differentiated banks i.e.,
not only using technology to drive efficiencies and cost Payment Banks that will be allowed to sell third-party mutual
reduction in the back-office, but also developing their funds will help increase the market reach of the fund
front-office digital capabilities. Fund houses offer a range industry.

Fund houses are moving toward a paperless experience, and an efficient and easy
transaction process
Effect of digital technologies on the mutual fund investment transaction process:

Paperless experience Efficient easy real-time process


The entire transaction chain from receiving money Digital platforms have made investing in mutual funds
to investment to redemption can be easily completed seamless, efficient and instantaneous. A majority of
on digital platforms without any physical or on-paper new-age investors, especially tech-savvy millennials,
requirements. Moreover, the introduction of e-KYC have switched to online platforms for buying and selling
using Aadhaar is expected to play a game-changing MF schemes as well as systematically transferring
role in online investing. With e-KYC, the account- money between funds. Such platforms help to tap a
enablement process can be completed in a few minutes wider customer base by minimizing the paperwork and
vis--vis the usual requirement of two to four weeks. making the process instantaneous. Over the years, a
This could prove highly beneficial for the financial number of online platforms have come up, including
services sector as it enables instant verification and AMC websites, broker platforms and independent
56
substantial cost reduction by eliminating paper-based portals.
movement and storage. According to a survey by
MicroSave, using Aadhaar enabled e-KYC process for
customer acquisition by banks (for account opening)
and by telecom operators (for pre-paid mobility) could
result in approximately INR100 billion of savings over
54
the next five years. This figure could be even higher
with other financial services businesses also turning to
e-KYC to make the account-opening process seamless
and efficient. SEBI currently permits investments of
INR50,000 each financial year per mutual fund for
55
Aadhaar-based e-KYC using OTP verification.

53

How Technology Is Shaping The Indian Mutual Fund Industry, BusinessWorld, 3 May 2016; Indian mutual fund industry: The road ahead, ICRA-Assocham
Report, November 2015; Ease of doing business, The Economic Times, 22 March 2015
54
Aadhaar enabled e-KYC can save Rs 10,000 cr over next 5 yrs : Survey, Business Standard, 18 March 2016
55
How to do E-KYC for mutual fund investments, The Economic Times, 29 February 2016
56
The best ways to buy mutual funds online, The Economic Times, 20 June 2011; Investing in mutual funds? Heres the cheapest, easiest way, NDTVProfit, 7
October 2013

Mutual Funds: Ready for the next leap 33


Digital is helping enhance distribution reach
Digital advances have not only ensured distribution efficiencies, but also helped create predictable revenue streams in the
low-margin business. Earlier, distributors needed to put in significant effort in operational tasks, but digital platforms have
helped them focus more on research and tracking markets rather than on individual client visits and extended paperwork.
Tablet and mobile apps are helping mutual funds increase reach in B-15 locations. Moreover, there have been several
industry-wide initiatives to help distributors build digital capabilities in order to serve investors better.

Industry-wide digital platforms supporting mutual fund distribution in India:


Stock exchange platforms MF Utility
In order to allow mutual fund distributors to leverage AMFIs MF Utility (MFU) transaction platform lets
the stock exchange infrastructure to expand their investors invest online across 25 fund houses using
58
reach, in 2014 SEBI allowed distributors to use the a common account number (CAN). MFU enables
stock exchange platform for non-demat transactions investment in multiple schemes through a single
as well for sale or redemption. Stock-exchanges such window and also provides 24x7 access to composite
as the Bombay Stock Exchange (BSE) and the National portfolio information and portfolio holding as well
Stock Exchange (NSE) have set up digital platforms as industry-level value-added services such as alerts
StAR Mutual Fund and MFSS, respectively. Collectively and triggers to help investors effectively monitor
these platforms witnessed 1.9 million transactions in and manage investments. The platform is a shared
FY15. In May 2016, the BSE eased registration norms infrastructure of AMCs to improve efficiency in terms
59
by removing minimum paid-up capital and net worth of time and cost by reducing duplication.
requirements to attract more participants on its MF
trading platform via distributors. In July 2016, BSE While some distributors rely on external digital platforms
also launched Paperless SIP (systematic investment such as those provided by industry bodies, other have
plan), which allows mutual fund investors to make built their own platforms or rely on those provided by fund
transactions through various payment modes. This is houses.
60

an additional feature on BSEs mutual fund platform,


StAR Mutual Fund, which would allow mutual fund
distributors to register SIPs for their clients. StAR Case study: digital distribution platforms
Mutual Fund has become the largest MF distributor
Fund house DSP BlackRocks IFAXpress platform
platform in India with more than 400,000 SIPs per 61
for distributors
month. NSE-NMFII plans to link investors PAN to
its backend database to pull out details of previous In 2015, DSP BlackRock (DSPBR) launched an online
MF transactions outside of NSE in order to help the platform IFAXpress for independent financial advisers
distributor provide the investor a holistic view of their (IFAs). This digital platform provides distributors
57
portfolio. the option to automate across processes, including
execution, portfolio monitoring and reporting,
and portfolio rebalancing. It provides transaction
capabilities and advanced analytical insights to its
distributors such as trends in AUM growth and client
acquisition as well as in-depth analysis of AUM mix. A
key feature of IFAXpress is that distributors can open
a folio for a client, who has a verified KYC status,
57

BSE eases norms for trading on its mutual fund platform, The Economic even if the client does not have an existing folio with
Times, 13 May 2016; BSE introduces Paperless SIP for mutual fund DSPBR. The platform is linked to R&T CAMS, and once
investors, IndiaToday, 12 July 2016; Mutual Fund orders via stock
exchange platforms double to 19 lakh in FY15, The Economic Times, 6
a distributor registers on the platform, it can access
April 2015; BSE introduces Paperless SIP for mutual fund investors, The client data and assets under advisory. IFAXpress has
Economic Times, 12 July 2016; Why MF distributors go online, Mint, 15 resulted in a significant boost in the sale of DSPBRs
April 2015
58
MF Utilities starts online platform, Mint, 5 November 2015; MF Utility money market funds, which did not happen earlier
extends online transaction facility in direct plans to investors from 1st Jan, from the advisor channel because of lack of economic
CafeMutual, 30 December 2015
59
New mutual fund platform to make transactions easier, BusinessToday, viability.
March 2015
60
Why MF distributors go online, Mint, 15 April 2015
61
How Technology Is Shaping The Indian Mutual Fund Industry,
BusinessWorld, 3 May 2016; DSP BlackRock IFAXpress a hit among
distributors, CafeMutual, 4 August 2015; DSP Blackrock launches
IFAXpress, biz platform for independent financial advisors, The Economic
Times, 10 June 2015; DSP BlackRock bets on IFAXpress to drive growth,
Business Standard, 7 October 2015

34 Mutual Funds: Ready for the next leap


S
EBI intends to allow sale of mutual funds on T
he advent of robo-advisors in mutual fund
e-commerce platforms distribution
SEBI is planning to give mutual funds an online push, mainly to The mutual fund distribution space is witnessing disruption,
make them more cost-effective and to eliminate the additional with automation redefining many fields and offering less
distributor layer between fund houses and investors. In expensive modes to reach a wider audience. Different
December 2015, SEBI announced that it plans to allow the sale models are emerging while some offer direct plans with
of mutual fund units on e-commerce platforms. E-commerce a fixed advisory fee, others offer regular plans with robo-
64
website have a wide reach and have gained acceptance advisory and financial planning as their core strength.
among customers, and can help unlock the buying power of Robo-advisors essentially automated platforms that
the vast majority of internet and mobile phone subscribers provide advice on portfolio management and help investors
in the country. In May 2016, a SEBI panel on the digitization buy financial products have emerged as a global
of financial services recommended the sale of mutual funds phenomenon. According to a research by Citi, robo-advisors
through established online marketplaces. The capital market are set to grow to ~US$5 trillion in terms of assets managed
65
regulator plans to assess online marketplaces in terms of certain by 2025 from US$14 billion at the end of 2014. Robo-
criteria such as minimum net-worth, sales, after-sales track advisors are also gaining popularity in India. However, India
record, brand popularity and customer base to sell mutual is yet to witness a proliferation of pure robo-advisors (similar
fund products. The panel has also recommended removing to those present in western economies) as there is a lack of a
additional KYC requirements on e-commerce sites as customers wide bouquet of index funds and ETFs that robo-advisors can
66
will be making payments through banks. The regulator may offer at low costs. Currently, most robo-advisors primarily
impose an investment limit of INR50,000 for non-KYC investors offer mutual funds as the solution for financial objectives.
on such platforms in order to check money-laundering and These platforms bring in more transparency, better services
62
other fraudulent activities. Individual investors rely heavily and lower costs. Most robo-advisors are free of cost and
on distributors for purchase of mutual funds; hence, a crucial earn from trail commissions, while some firms charge an
point to be observed would be the receptiveness of investors to advisory fee. According to Tracxn, at present there are 39
67
making online investment without any guidance from financial robo-advisory firms in India.
advisors. Another point would be differential pricing for these
63
units compared with existing share classes.

68
Case study: robo-advisor interfaces in India
Goal-oriented investments: FundsIndia.com is an online health and life insurance, and also gives tax planning
platform that offers mutual funds. It has four portfolios guidance. The algorithm also analyses expenses and gives
(known as smart solutions) targeted toward four goals: expense rationalization tips. Portfolios are reviewed and
childs education, childs marriage, retirement and rebalanced half-yearly. Investors are charged an annual
first-time investment. Schemes are suggested based fee of INR1,000.
on the number of years till the goal and the monthly A
utomated: Scripbox offers a ready basket of funds on
investment amount. The portfolio is reviewed regularly the basis of an investors investment horizon. It offers
and rebalanced accordingly. three portfolios of mutual fund schemes equity, debt
F
ull-service advisors: ArthaYantra offers online end-to- and tax savings which are curated using an in-house
end financial planning, from evaluation to management. research process. An investor with a longer time frame is
Risk profiling is done online with the help of behavioral typically directed to a basket of four pre-selected equity
finance. Investors inputs are acquired on 60 model funds, while an investor with a shorter time frame is
portfolios and an optimum one is designed. Once the directed to a portfolio of debt schemes. These baskets
report is generated, a financial planner explains it to the of funds are selected based on proprietary algorithms.
investor. The company provides mutual fundrelated Portfolios are reviewed annually. This platforms main
investment advice, as well as recommendations on objective is to reach youngsters and first-time investors.

Going forward, a number of robo-advisors are expected to enter the Indian fund management sector. While some will connect
directly with investors (B2C model), others will provide algorithmic platforms to distributors (B2B model) to enable them to provide
portfolio solutions to their clients. As the sector evolves, more innovation is expected in terms of lower costs, more complex
financial planning etc. Online mutual fund distributors and robo-advisors are also witnessing interest from private equity players,
69
which have already invested INR1.5 billion into such platforms. While robo-advisors may not pose a threat to value-based
financial advisory services, they may pose challenges to pure transactionbased distributors who are mainly focused on offering
convenience. Some industry experts also believe that going forward, all types of distributors robots, fee-based advisors and
transaction-only distributors will co-exist as there is low penetration of distributors in the country, with only a small number of
70
distributors catering to the large population base.
62 68
 Sebi set to allow e-commerce firms to sell mutual funds, Mint, 27 June 2016 Robo advisory could change distribution, Mint, 22 September 2015; Robo-
63
Indian mutual fund industry: The road ahead, ICRA-Assocham Report, advisory: which one is for you?, Mint, 20 June 2016; Robo advisors best for
November 2015; SEBI using technology to push for growth of Mutual Fund small investors, Business Standard, 18 October 2015; The advent of robo-
industry, IndiaInfoline website, 28 October 2015 advisors, ValueResearch, 1 September 2016
64 69
Online MF distributors, robo advisors catch fancy of private equity players, Online MF distributors, robo advisors catch fancy of private equity players, The
The Economic Times, 1 April 2016 Economic Times, 1 April 2016
65 70
Robo advisory could change distribution, Mint, 22 September 2015 Robo advisory could change distribution, Mint, 22 September 2015; Robo-
66
Robo advisory could change distribution, Mint, 22 September 2015 advisory: which one is for you?, Mint, 20 June 2016; The nuts and bolts of
67
Robo-advisory: which one is for you?, Mint, 20 June 2016 Robo Advisory, Business Line, 29 May 2016
Mutual Funds: Ready for the next leap 35
6.
Regulations:
Global best practices

36 Mutual Funds: Ready for the next leap


Evolution of the regulatory environment for the asset management industry
After the global financial crisis, regulators and governments across the world have moved to stringent compliance standards.
They have increased their focus on tighter oversight of financial services sector and introduced new regulations at a rapid
pace. These regulations focused mainly on containing risk and protecting investors. There has also been a very evident trend
toward the globalization of financial regulatory policies.

Snapshot of key regulations affecting asset managers across the globe

North America
Europe (and Eastern Europe
Dodd-Frank Act, Basel III, AIFMD,
emerging markets) UCITS,
FTT and IFRS Convergence are
AIFMD, EMIR, extraterritorial
likely to dominate the regulatory
Dodd-Frank, FATCA, Basel III, plus
agenda.
MiFID II, PRIPs, MAD II, AMLD
and especially FTT all contribute
to a complex and concentrated
period of regulatory reform in the
region over the next 3-5 years
and beyond.

Latin America
Improved regulatory regimes with
the intention to come into line Asia-Pacic
with the G20 recommendations. A number of initiatives are being undertaken
For example, a higher percentage by regulators to reduce bureaucracy, speed
of adherence to Basel core Rest of the world up the process of bringing new products to
principles than the developing Many of the emerging markets such market and stimulate market activity within
markets of Asia (Source: IMF). as Africa and the Middle East their jurisdiction by attracting more participants.
currently under extreme civil unrest, Investor protection, through stricter codes of
making the application of national conduct for intermediaries, is also a high priority.
and regional regulation extremely The rst steps toward an integrated marketplace
challenging. will be implementation of the proposed Asia
passporting scheme.

Source: EY Global wealth and asset management industry outlook

Global regulators have imposed a multitude of regulations of redemption to instantly give investors their money back,
on the asset management sector. While banks have focused even in stressed markets under tight liquidity conditions.
72
on shrinking their balance sheets after the financial crisis, Hence, the FSB has proposed certain measures.
the asset management sector has rapidly expanded, from
National regulators to impose stricter reporting norms
US$50 trillion in 2004 to US$76 trillion in 2014, accounting
and gather more data, monitor leverage and ensure fund
for 40% of assets in the global financial system. Asset
houses effectively utilize tools such as fees and gates to
managers have also moved into the shadow banking space
71 discourage redemptions in stressed markets
for instance, lending of securities.
Stress testing, which has become common in the banking
As a result, the Financial Stability Board (FSB) raised
sector, to be applied to funds as well
concerns regarding the ability of open-ended funds in case

71
G20 regulators aim to rein in asset managers with new rules, Business Insider, 22 June 2016.
72
G20 regulators aim to rein in asset managers with new rules, Business Insider, 22 June 2016.

Mutual Funds: Ready for the next leap 37


Key regulations affecting the mutual fund industry across the globe

The US
Mutual fund houses are categorized as regulated Data reporting requirements: In June 2015, the
investment companies (RICs) and subject to regulations SEC announced the Form ADV Proposal and the
of RICs. Registered funds and investment advisors in the Fund Reporting Proposal. It requested for additional
US are regulated under the Investment Company Act inputs to Form ADV (an annual form with details
(1940) and the Investment Advisers Act (1940) by the regarding business, AUM etc.), namely aggregated
Securities and Exchange Commission (SEC). ETFs, REITs statistics about separate accounts, such as AUM,
and unit investment trusts also classified as RICs. Foreign holdings breakdown by asset type, information about
firms can enter the US market by establishing an RIC. derivatives use, breakdown of AUM by client type
US RICs managed US$18.1 trillion in assets at year-end and custodian information. The regulator introduced
2015, with the mutual fund and ETF markets managing two new forms N-PORT and N-CEN for enhanced
US$17.8 trillion in AUM the largest market in the fund reporting and also included a provision for
73
world. US mutual funds are subject to a comprehensive electronically providing reports to shareholders.
regulatory regime and need to abide by certain
Comprehensive ETF rule: The SEC is considering a
provisions, such as ensuring liquidity (invest at least 85%
separate framework of rules to govern the burgeoning
of the portfolio in liquid securities, which can be disposed
exchange traded products (ETP) market covering
of within seven days), leverage (maintain a maximum
trading, listing, product structure and focusing on
ratio of debt-to-assets of 1:3) and transparency (provide
risks specific to ETFs.
information about their operations, financial conditions,
contractual relationships to regulators, investors etc.). Liquidity risk management: In October 2015, the
Mutual funds also have to designate a chief compliance US capital market regulator proposed that funds
officer (fund CCO), who is responsible for administering be required to predict the number of days taken to
74
the funds compliance policies and procedures. liquidate each position in the fund at a price close to
the current value (days to liquidate bucketing of fund
In July 2014, the SEC adopted amendments to money
holdings) and determine a minimum percentage of
market mutual fund (MMF) rules. The new rules require
the portfolio that must be held in assets that can be
a floating net asset value (NAV) for institutional prime
sold and settled in three days (three-day liquid asset
MMFs based on the market value of fund assets and
minimum). It also prohibited funds from holding more
provide non-government MMF new tools, such as liquidity
than 15% of assets in securities that are deemed
fees and redemption gates, to address runs. The new
illiquid (15% illiquid asset limit).
rules, which are to be fully implemented by October
2016, are impacting the US$2.7 trillion of assets in Derivatives risk management: In December 2015,
MMFs with more than US$200 billion shifted from prime the derivatives proposal was issued, which would
funds (those that can invest in a wider variety of assets) to introduce leverage limits based on gross notional
75
government funds (limited to government securities). exposure, and the only assets that would be permitted
for asset segregation purposes would be cash and
In December 2014, the SEC laid out a program for
cash equivalents. Asset segregation is a requirement
modernizing the regulation of US-registered mutual funds
that funds hold liquid assets against derivatives
and investment advisers. The SEC is looking into the
exposure.
following areas of the US open-ended fund industry to
76
modify regulations: Transition of client assets: The SEC also plans to put
in place a rule to ensure that asset managers have a
plan for transitioning the management of client assets
if there is a material disruption to an asset managers
business.

73

Global Management of Regulated Funds A Comparison of UCITS and U.S. Mutual Funds, K&L Gates, 2014; 2016 Investment Factbook, ICI, http://www.
icifactbook.org/ch1/16_fb_ch1
74 
Comprehensive Regulatory Regime for U.S. Mutual Funds, //www.ici.org/pdf/14_ici_usfunds_regulation.pdf
75
US money market fund reform: an explainer, Financial Times, 29 April 2016; SEC Adopts Money Market Fund Reform Rules, SEC website, 23 July 2014
76
Modernization of US Asset Management Regulation, BlackRock, March 2016

38 Mutual Funds: Ready for the next leap


The EU
The EU is the worlds second largest fund market after the US. The following are some of the key regulations applicable for
fund managers in the EU:

Undertakings for Collective Investment in Transferable Securities (UCITS): With the implementation of the UCITS
legislation, the entire European continent has moved toward a single market in terms of the manufacturing and distribution
of asset management products. This regime provides a single European regulatory framework for an investment vehicle,
allowing a manager to market the vehicle across the EU irrespective of the country it is domiciled in. UCITS can also be
sold to non-EU countries such as Switzerland, Hong Kong and Singapore. The original UCITS directive was published in
1985 and UCITS regulations are continuously evolving: UCITS IV was published in 2010 and UCITS V guidelines will be fully
77
applicable from January 2017.

UCITS I 1985 - Original UCITS directive published.

UCITS II Abandoned: UCITS II was abandoned in 1998 after EU Member States failed to reach an agreement on its scope and
purpose. Key provisions included much of the framework of UCITS III.

UCITS III 2001: Firms were given until February 2007 to ensure their funds were UCITS III compliant. UCITS III was divided into
two distintive directives:
Management directive: Creation of the European Passport whereby a UCITS fund authorized in its home state could be s
old anywhere within the EU. Also required the use of a simplied prospectus detailing the key features of a fund. Product
directive: Allowed for investments in a wider range of asset classes with a corresponding distinction between
non-sophisticated and sophisticated funds.

UCITS IV 2009: UCITS IV was effective 1 July 2011. Key provisions included the following:
Streamlined regulator to-regulator notication procedures
Management company passport created
Key Investor Information (KII) document replaced the simplied prospectus
Master-feeder fund structures are introduced
Framework for domestic and cross-border fund mergers is created

UCITS V Spring 2016 (estimated): UCITS V amendments were proposed by the EU Commission in July 2012 and approved by
European Parliament in April 2014. Will align UCITS Directive with the AIFM Directive. Key provisions include the following:
Depositary regime updates, including their appointment and eligible entities, oversight duties, cash-monitoring duties,
safe-keeping duties, delegation and overall liability
Establishment of remuneration policies and practices that promote sound and effective risk management and do
not encourage risk-taking. Remuneration structures will need to include rules on variable and xed compensation,
including a requirement that at least 50% of variable remuneration be in the form of units
Creation of a sanctions regime and whistle-blowing procedures for reporting incidents to authorities

UCITS VI To be determined: Potential areas covered include the following:


Eligible assets, use of derivatives and efcient portfolio management techniques
Liquidity management
Depositary passport
Money market funds
Long-term investment funds
Consistency with
AIFM Directive
Source: European mutual funds: An introduction to UCITS for US asset managers, EY Report, 2015

79
Alternative Investment Fund Managers Directive (AIFMD): Markets in Financial Instruments Directive (MIFID):
This EU legislation aims at increasing investor protection MiFID has been the cornerstone of capital market regulation
and reducing systematic risk by creating a harmonized EU in Europe since its implementation in November 2007. MiFID
framework for managers of alternative investment funds II, the EUs response to the financial crisis, is a top compliance
(AIFs) i.e., non-UCITS. An AIF covers a wide range of funds priority for asset managers, global giants and niche
and structures and includes hedge funds, real estate funds, specialists. The directives main objectives are to increase
private equity funds and US 40 Act funds. AIFMD came competition and consumer protection in investment services.
78
into effect in July 2013. It not only impacted the way
77
funds are marketed and distributed in EU, but also put forth 
European mutual funds: An introduction to UCITS for US asset managers, EY Report,
2015; Six Months and Counting Key Dates Before UCITS V Goes Live, Matheson,
provisions on increasing transparency on key issues such as September 2015; UCITS V: Remuneration, Matheson, May 2016
78
remuneration for instance, linking compensation with fund 79
AIFMD, http://www.investeurope.eu/policy/key-topics/manager-fund-regulation/aifmd/
The world of financial instruments is more complex. Time to implement change.
performance and payment in units of own funds. Capital markets reform: MiFID II, EY Report, 2015

Mutual Funds: Ready for the next leap 39


MiFID II objectives and core measures

Trading bans and position limits for commodity derivatives


External circuit breakers for HFT trading (breaker at venue
level)
Testing of algos by participants
Additional reporting requirements to regulators (trade and
transaction reports, algo reporting, expanded asset class and Developments in the
data scope) market, products and
technology have outpaced
National competent authorities to apply sanctions when in provisions of the original
breach directive, with
Regulatory oversight of product, including ban or limitations activities such as HFT
on marketing to retail investors
Third-country access through national regimes until
External
effective equivalence test by European Commission allowing
controls/
passporting
reporting

Insufficient levels
of investor protection Investor
MiFI
due to the rapid protection
innovation and
growing complexity in
financial instruments
resulting in mis-selling Ma
transp

Revised suitability and appropriateness regime especially for


complex products with embedded derivatives (including
UCITS) Increased marke
Ban of inducements to independent advisers and discretionary for market par
managers and more stringent disclosure regime for payments market fragm
paid and received made the tradin
more complex
Enhanced conduct rules when designing new products and
tightened execution-only regime

Source: The world of financial instruments is more complex. Time to implement change. Capital markets reform: MiFID II, EY Report, 2015

40 Mutual Funds: Ready for the next leap


Enhanced governance with prescription around governing
board and committee composition, fitness and propriety, and
time commitment
Implementing systems capable of record keeping for a
minimum of five years
Exposure of weaknesses
Increased scope and role of compliance (semi-independence)
in the regulation and
transparency of non-equity Tone from the top
financial instruments, both
at trading and retail
investment advice levels

Internal
controls/
governance

Creation of a level playing Equity trading obligation on RM, MTF and SI only
ID II Market
field between market (no off-market trading)
participants since the
structure Mandatory trading obligation for OTC derivatives
envisioned benefits of
increased competition Introduction of organized trading facility (OTF) for
have not always been non-equity instruments
arket passed on to end
parency Limitation on trading on dark pools for equities
investors, retail or
and equity-like products
wholesale clients
Open access to trading venues, CCPs and
benchmarks

et transparency
rticipants since
mentation has
ng environment
x and opaque

Increased regulatory and client reporting requirements for all


asset classes on RM, MTF, OTF and SI
All RMs, MTF and OTFs to publish bid/ask and depth of market
(per product)
Public firm price quoting requirements for SIs for liquid
instruments
European Consolidated Tape (ECT) approaches
Synchronized business clocks for trading venues and members

Mutual Funds: Ready for the next leap 41


80
Case study: impact of the Retail Distribution Review in the UK
The Retail Distribution Review (RDR), which was implemented on 31 December 2012, introduced new rules for
investment advisers and platforms, such as higher minimum levels of adviser qualifications, amendment of disclosure
rules in relation to adviser charging and services, and realignment of adviser and platform incentives with that of
investors by abolishing commissions. According to the FCAs post-RDR implementation review in December 2014,
the removal of commissions led to a decline in product bias from advisor recommendation, significant reduction in
direct-to-customer (D2C) platform charges, a decline in retail investment product prices and a level playing field for all
providers (particularly those that sold low or no-commission products. Moreover, the majority of financial advisors are
qualified to the new minimum standards, thus leading to increased professionalism in the advice market. However, the
cost of advice has increased, but this had created opportunities for simplified and automated advice as customers are
demanding increased value for money. Firms have also improved in clearly disclosing to clients the cost of their advice
and the scope of their services.

Asia-Pacific
Asia is the third-largest mutual funds market
worldwide, after the US and Europe. The Asia fund
passport initiatives could be seen as the first attempt
toward the unification of the Asian funds markets.
The objective of the passport is to provide collective
investment scheme operators with a common
framework that offers them regulatory consistency
across multiple jurisdictions.
ASEAN Collective Investment Scheme (CIS): ASEAN
CIS was launched in August 2014 to provide a fund
passport across Singapore, Malaysia and Thailand.
In September 2015, regulators from the three
jurisdictions jointly issued a handbook to implement
the Streamlined Review Framework to facilitate
operational guidance for industry practitioners and
to ensure faster access to capital and shorter time
to market.
Asia Region Funds Passport (ARFP): In April 2016,
Australia, Japan, Korea and New Zealand entered
into a Memorandum of Cooperation. ARFP aims
to facilitate cross-border distribution of managed
fund products across the Asia region. The eligibility
requirements to be a passport fund include US$500
million in AUM, at least US$1 million additional
capital, minimum qualification requirements and
years of experience for officers (for instance,
the CEO must have at least 10 years of relevant
experience), and compliance with investment
81
diversification.

80
 Post-implementation review of the Retail Distribution Review Phase 1, FCA, December 2014
81
Asia Region Funds Passport: Fact sheet, April 2016, //fma.govt.nz/assets/Fact-sheets/160428-ARFP-Fact-sheet.pdf ; Asian rivals for Ucits funds look a bit
limp, Financial Times, 11 October 2015; Asia Region Funds Passport update, McMahon Clarke, May 2015

42 Mutual Funds: Ready for the next leap


Complex regulatory landscape
Multitude of regulations in overlapping areas

Regulatory changes are expected to reshape not only internal policies and procedures, but also the fund houses business
models. Regulations need to be aligned both at a domestic as well as a global level. Asset managers are considering multiple
related regulations for instance, in Europe aligning Dodd Frank, Basel III/Capital Requirements Directive (CRD) IV, European
Market Infrastructure Regulation (EMIR), Market Abuse Directive (MAD) II and MiFID II under one regulatory change program
to provide a much more controlled, consistent and efficient implementation, avoiding duplication of work in overlapping
82
areas.

Organizations are having to deal with Illustrative approach, will vary from organization to organization
and may be subject to change as regulatory requirements evolve Coordination of new
the challenge of multiple regulations
regulatory implementation
with overlapping themes. Critical is a
holistic approach covering all relevant
regulations and building out projects
MiFID II UCITS AIFMD EMIR CRD IV AML PRIPs/ FTT FATCA
on a topical basis.
IMD II

Legal entity/business model

Business conduct/compliance
Distribution

Trade execution/client advisory


Clearing and settlement
Regulatoryreporting
Reference data andidentiers
Collateral and margin

Risk management

Capital

Pricing and valuations

Product control and accounting

Tax

0
Source: MiFID II: Time to take action Wealth & Asset Management, EY Report, 2014

Increased cost of regulatory compliance L


ow tolerance for regulatory breaches
The cost of regulatory compliance is expected to leading to large fines
significantly impact asset managers expenses base. Going Increased scrutiny by regulators and low tolerance for
forward, increased cost of regulatory compliance may breaches have resulted in huge fines for asset managers.
come as a heavy burden for small players, which may not Systems and control weaknesses are one of the most
be able to make equivalent levels of investment and remain common reasons for which asset management companies
competitive. Larger firms are exploring ways of sharing the have been fined by regulators during the past year. For
cost with clients and developing value-added services to instance, the UK asset management sector has witnessed a
complement the core compliance requirement. number of large fines for these reasons.

82
Capital markets reform: MiFID II, EY Report, 2015

Mutual Funds: Ready for the next leap 43


Key rules in global regulations that may impact the Indian mutual funds regulatory regime`
Investment professionals minimum
qualifications/experience requirements Remuneration proposals`

M
IFID II requires certain minimum knowledge and T
he UCITS V remuneration guidelines require UCITS
competency standards for staff providing relevant managers to balance fixed and variable pay and
services by January 2018. Professional and pay a substantial portion (at least 50%) of variable
examination bodies have recommended specific remuneration in non-cash components such as units
qualifications, such as CFA charter and Investment of UCITS. Significant UCITS managers should also
85
Advice Diploma for Investment Advisors. establish a remuneration committee.
I n the UK, after the RDR, financial advisers need to A
IFMD has put forth provisions such as linking
achieve a higher minimum standard of qualification compensation with fund performance and paying in
before they are allowed to provide advice: from a units of own funds.
benchmark of Financial Planning Certificate (level
I n the Netherlands, there is a cap of 20% of gross
3 qualification) to a Level 4 Diploma qualification,
salary on the bonuses paid to finance professionals,
which is an FCA-approved program that meets
including asset management staff.
the FCAs RDR qualification requirement for
84
independent retail financial services advice. I n Singapore, the Monetary Authority of Singapore
Moreover, every individual financial advisor needs (MAS) recommended that financial advisors adopt
to complete at least 35 hours of professional a balanced scorecard framework for remunerating
training each year to stay up to date with industry representatives, using non-sales key performance
and regulations. indicators, such as the quality of advice and the
suitability of recommendations. The MAS has
C
ountries participating in the ASEAN Fund Passport
banned product-specific incentives and sales
System require fund managers to have certain
bonuses.
years of experience to advise investors.

Ban on commissions and move to advisory model


86
M
IFID II ban on inducements for independent financial advisers to ensure investor protection.
T
he RDR in the UK abolished commissions and paved the way for a fee-based advisory model. The Netherlands has
also banned inducements.
T
he Australian regulator was the first to ban commission in 2012 under its Future of Financial Advice (FOFA)
87
legislation, which imposed a ban on conflicted remunerations.

Transparency/reporting

M
IFID II requires portfolio managers to record telephone conversations that lead to or are likely to lead to portfolio
88
transactions.
M
iFID II requires firms to disclose all costs and charges associated with a clients investment. For example, costs that
may not typically be disclosed to consumers, such as transaction costs, will need to be disclosed in the future.
I n UK, the Financial Services User Group (advisor to the EC) has proposed that financial advisors disclose the reason
behind recommending an active fund in order to support retail uptake of passive products.
T
he Netherlands has implemented a new voluntary code, which facilitates transparency on fund costs. Firms that
adhere to the code provide investors with consolidated figures showing the firms own costs and charges related to
investment products and transaction costs of their investments.
M
IFID II requires firms to keep a record of actual and potential conflicts of interests for the firm (including its
managers, employees and tied agents).
M
iFID II imposed new requirements on firms and trading venues to produce public data about executed transactions.
Firms must annually summarize and publish their top five execution venues by trading volume for each class of
financial instrument, as well as information on the quality of execution obtained.

44 Mutual Funds: Ready for the next leap


Investor awareness`

I n Singapore, a customer knowledge assessment is required by the Monetary Authority of Singapore to assess a
retail clients investment knowledge and experience before they can be sold select investment products.

83
https://www.fitchlearning.com/sites/default/files/MiFID%20II%20summary%20sheet_final.pdf
84 
http://institute.ifslearning.ac.uk/Qualifications/QualificationsinFinancialAdvice/DipFA.aspx; http://www.professionaladviser.com/professional-adviser/
feature/2104173/rdr-qualifications-definitive
85 
UCITS V: Remuneration, Matheson, //www.matheson.com/images/uploads/publications/UCITS_V_Factsheet_on_Remuneration.pdf
86 
The receipt of monetary and non-monetary benefits under Mifid ii, CharlesRusselSpeechlys, 9 February 2016
87 
FOFA - ASIC guidance and FOFA - Background and implementation, ASIC website; Trailer fees are first to go, Financial Post, 5 July 2010; FoFA,
Financial Planning Association of Australia, /fpa.com.au/policy/policy-issues/fofa/
88 
MiFID II Expected to Have Significant Impact on Investment Managers, Skadden, January 2016

Mutual Funds: Ready for the next leap 45


7.
Goods and
Services Taxs
(GST) impact
on the mutual
fund sector

46 Mutual Funds: Ready for the next leap


The Rajya Sabha has passed the GST Bill, paving the way for This could result in the advisory services provided by mutual
the most significant tax reform and probably the second- funds to service receivers outside India being liable to tax,
most significant economic reform since Independence. thereby increasing the cost of such services to the overseas
With the Bills passage, the advent of the GST is now only a advisory entities or funds. This issue can be addressed by
matter of time. altering the place of supply rules or by bringing in some
kind of special exemption for supplies collected in foreign
The Finance Ministry, pursuant to the consensus from the
exchange.
Empowered Committee of State Finance Ministers, had
already released the draft of the Model GST Law on 14 For distribution costs, service tax now applies on a forward
June 2016 to the public. The Model Law throws light on the charge basis. Given the industry practice of paying
framework of the GST statute and provides a model to the commissions inclusive of service tax, under GST if the rate
States to enact their own GST acts. While the Model Law increases (from 15% to say 18% or 20%), the net commission
adopts various existing concepts from the Central and States earned by distributors will reduce. On the other hand, GST
Acts, it also introduces new concepts necessitated by the regulations may have a threshold of INR50 lacs for paying a
very nature of the GST. compounded tax of up to 1%. It is possible that distributors
may elect for this option, thereby potentially increasing
GST is expected to bring in more clarity, consistency,
their net commissions. Smaller distributors acting through
certainty and efficiency in the tax system. The law is at a
aggregators may prefer to work directly with AMCs to get
draft stage, inviting suggestions and recommendations
better exemptions/lower rate of tax.
from all the stakeholders. In the services sector, including
mutual funds, which did not have multiple taxes, GST will not For marketing spends, AMCs will have to closely examine
subsume other taxes. On the contrary, there would be an expenditure incurred in States where there are no
additional hit for investors, depending on the finalized rate operations (and, therefore, registration under GST). In such
of GST. States, credits could become a cost.

Although GST is expected to make it easier to do business Furthermore, AMCs/mutual funds may have a presence
in India, the draft law has raked up some questions and also across India or they could operate through a marketing/sales
some uncertainty on various vital aspects of taxation, such partner model. Under the present service tax legislation,
as: where AMCs have presence across India, they obtain
centralized registration, and the centralized location is
Place-of-supply rules for non-account linked services to
where they pay tax on revenue and avail input credits. Under
hinder certain services that are currently zero-rated,
the Model GST Law, AMCs will need to obtain registrations
e.g., export
in every state and comply with the tax payment, input
Applicability of tax on distribution costs credit and tax filing obligations. This will mean a significant
change in the manner in which revenue and expenses are
Marketing and activation spends across India
captured and reported. Also, the input credits of the GST
Inter-branch transactions liable to tax paid for supplies made at the branch level would have to be
Valuation of services, including domestic inter-branch captured and reported separately.
transactions This may result in accumulation of input credit at the branch
Multiple state-wise registrations level. This will also mean that transactions between two
different registrations will be treated as taxable supplies
From a taxability point of view, there may not be any and, therefore, need to be mapped, measured, offered for
significant changes i.e., fee-based incomes will continue to tax and reported.
be liable to tax or GST. There are mutual funds that export
advisory services to funds located outside India. Under the A possible resolution to this issue could be granting a central
current service tax legislation, these services are treated as tax registration to AMCs, with the ability to avail credits
zero-rated and not liable to tax. It is important to note that and pay taxes only in one of the States. This will involve
the place of supply of banking and other financial services extensive advocacy efforts by the industry to convince both
has been prescribed as the location of the recipient of such Central Government and State Governments regarding the
services. However, in cases where the service is not linked need and the workability of this proposal.
to the account of the recipient of services, the place of Organizations will have to work on assessing the impact of
provision of service would be the location of the supplier these changes on their business with regard to the following
of service. The term account has also not been defined aspects: cash flow, profit and loss account, business process
under the draft law. However, the definition of account and technology. A work plan should be put in place. Given
as contained in the present Place of Provision of Service that the implementation timeline that the Government has
Rule, 2012 is fairly narrow and covers only interest-bearing proposed is 1 April 2017, the period available for businesses
accounts. This implies that services in relation to qualifying to get ready is limited, and immediate action may be
accounts would be linked to where the service recipient is required for larger setups to be ready in time.
based; however, in all other cases, the location of the service
provider would be considered.

Mutual Funds: Ready for the next leap 47


Notes

48 Mutual Funds: Ready for the next leap


Notes

Mutual Funds: Ready for the next leap 49


Contacts Acknowledgement
Abizer Diwanji Rahul Shah
Partner & National Leader Financial Assistant Director, EY Knowledge,
Services, EY Rahul.shah2@in.ey.com
Abizer.diwanji@in.ey.com

Kirti Shenoi
Sameer Gupta Manager - Brand, Marketing and
Partner & National Tax Leader Financial Communication, EY
Services, EY Kirti.shenoi@in.ey.com
Sameer.gupta@in.ey.com

Jaspal Singh
Divyesh Lapsiwala Manager - Brand, Marketing and
Partner Indirect Tax Services, EY Communication, EY
Divyesh.lapsiwala@in.ey.com Jaspal.singh@in.ey.com

Tanmay Mathur
Writing & Editorial, EY Knowledge
Tanmay.mathur@in.ey.com

50 Mutual Funds: Ready for the next leap


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