Can Zerodha and Navi disrupt the mutual fund industry just by offering low-cost schemes?

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© Nishant Kumar Can Zerodha and Navi disrupt the mutual fund industry just by offering low-cost schemes?

On September 1, Zerodha, among India’s largest discount brokers, got the in-principle license to launch its mutual fund business from SEBI. To be sure, the fund house is still a few months or even a year away from commencing operations. It would now work to put its office, operations, systems and a team together before it applies for the final license.

Meanwhile, Navi mutual fund, started by Flipkart founder Sachin Bansal, has filed draft offer documents for 11 passively-managed schemes it plans to roll out, including one that would invest in one of US-based Vanguard’s exchange-traded funds (ETFs).

In earlier interviews to Moneycontrol, Nithin Kamath, founder and CEO of Zerodha had said that his fund house would launch low-cost, passively-managed schemes. Why are new fund houses keen to launch passive funds when most of India’s largest MF schemes are actively-managed?

Low-cost offerings

Start-up fund houses are well aware of the gigantic sizes of their largest competitors in the Rs 35 trillion Indian MF industry. Now,10 of the 43 existing fund houses already have assets worth more than a trillion rupees each. Seven of those, including the largest – SBI Mutual Fund – are bank-sponsored and thus benefit from massive branch distribution channels. The SBI Balanced Advantage Fund NFO collected Rs 14,500 crore, and is a case in point.

Offering low-cost passive schemes that do not come with fund manager risk is one way, as they just mimic the index they track.

In July, the Navi Nifty50 index fund was rolled with the direct plan carrying an expense ratio of just 0.06 percent.

Such low expense ratios matter. For instance, assume scheme A charges an expense ratio of 0.10 percent, and Scheme B charges 1.2 percent. Assume you invest Rs 1 lakh each in both the schemes for a period of 10 years and equity markets go up by 14 percent. Scheme A will give you Rs 3.67 lakh, while scheme B will give you Rs 3.33 lakh. That’s a saving of nearly Rs 34,000, purely due to low expenses.

Large-cap funds unable to beat benchmarks

Regulatory changes over the past few years have made it tougher for large-cap MFs to beat their benchmark indices. As per a Moneycontrol analysis, about 70-80 percent of large-cap funds that used to beat their benchmark indices up until 2016, on a three-year time frame. These days, barely 20 percent of large-cap funds beat their benchmark indices.

From an average inflow of Rs 254 crore and Rs 354 crore into index funds in the years of 2019 and 2020, respectively, so far this year investors have pumped in an average of Rs 1,182 crore.

Bengaluru-based investment coach Harish Rao says, “When new fund houses get launched, it’s good to test the waters with passive funds. By removing the risk of fund manager decision, it’s easy to sell to the masses. If your (passive) funds do well, it’s good. If they do not do well, people will blame the market. Nobody would judge the fund houses.”

Making it easier to invest

Technology driven MFs may just draw comfort from fintech distributors who have been adding new investors aggressively. In the past few years, fintech distribution firms have been adding more number of investors that traditional distributors. As per rough industry estimates, of the top 21 distributors in the country in terms of the most number of new systematic investment plans (SIP) accounts opened in the month of July 2021, nine were fintech distributors whose chunk- or in many cases, all- of their customers transact online.

Groww was set up in 2016. It recently got into the asset management business by acquiring Indiabulls mutual fund. But Groww led the pack in July by opening 3.67 lakh new SIP accounts.

Experts say new-age digital-focused fund houses such as Zerodha and Navi would also attract new customers with ease. “I am quite confident they will,” says Ajit Menon, CEO of PGIM Mutual Fund. Menon says that they would not just incrementally add more number of new customers than many other fund houses, they will also put pressure on existing fund houses to improve their digital footprint. He adds, “They will put the fear of God in many existing fund houses and make them think that if Navi and Zerodha can do it, so can we.”

A digital approach and a focus on passive funds is also one reason why Zerodha and Navi mutual funds are based in Bengaluru and not in Dalal Street in Mumbai, the traditional hub of the Indian MF industry.

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