The 2017 book, ‘How Fund Managers are making you Rich’, resonates with the advertisement jingle ‘mutual funds sahi hai’ (mutual funds are terrific). But the book also talks about a meeting between Ajit Dayal, the founder of Quantum Mutual Fund, and senior management at other mutual funds (MFs): “Dayal…called the mutual fund industry a den of thieves”. It is impossible to reconcile the title of the book with that quote.
There are others who are critical of MFs. Sanjiv Shah, former CEO of Goldman Sachs’ Indian MF and co-founder of Benchmark AMC, has written in an article that: “If one looks at the way [mutual fund asset management company] AMC business is structured, you wouldn’t be wrong to surmise that intermediaries [and not the end investors] are the clients”.
These statements are in strong contrast to the fact that, in general, mutual funds are infinitely better products than insurance investment products. By a rough estimate, 2% of MF products—across MF houses—are amongst the best investment products in India. Ironically, it is because of this that it is worth discussing the flaws in MFs and how one can find the needle in the haystack.
To understand the flaws in the system, ones that ultimately cost individual investors a significant share of their overall investment, let’s delve into a general MF investment scenario.
Ms X signs up with an MF distributor. These distributors are, for all intents and purposes, salespeople. Through the distributor, Ms X invests Rs 1 crore ($142,857) in an MF scheme. The MF scheme is a pool of money that belongs to Ms X and other investors like her, and the money is managed by an asset management company (AMC) such as Reliance AMC or Aditya Birla Sun Life AMC.
Every year, the AMC deducts about 2%—around Rs 2 lakh ($2,857)—from Ms X’s investment in the scheme. From this amount, it pays around Rs 90,000 (US$ 1,286) to the distributor as an annual commission. The remaining Rs 1.1 lakh ($1,571) goes towards the AMC’s expenses (including advertising and salaries) as well as its profits. After this deduction, it invests the remaining amount across various equity shares.
This system works well for distributors and AMCs. As per estimates and conversations with industry experts, MF distributors automatically take an estimated Rs 15,000 crore ($2.14 billion) from individual/institutional investors’ MF investments each year. Large AMCs are similarly well taken care of. Anecdotally, India’s largest mutual fund HDFC AMC’s annual profit was Rs 722 crore ($103 million), with its five-year average Return on Equity of 42% per annum more than triple that of the average for the 50 largest listed companies in India.