Mutual funds play an indispensable role in capital markets, serving as a gateway for individuals and institutions to access a diverse range of securities. The Indian mutual fund industry has undergone a profound transformation over the past decade, showcasing remarkable resilience and expansion. The industry's assets under management (AUM) surged from US$ 108.8 billion (Rs. 9 Lakh Crore) in January 2014 to US$ 635.3 billion (Rs. 52.7 lakh crore), growing six-fold over ten years. This exponential rise can be attributed to a number of factors beyond market fluctuations. In this case study, we aim to present a thorough analysis of the mutual fund industry in India, focusing on the overarching landscape and exploring the key factors that underpin the recent boom in mutual fund investments in the country. This discussion also delves into the profound significance of mutual funds within capital markets, emphasizing their pivotal functions in fostering investment, managing risk, and enhancing market efficiency and liquidity.

Introduction to mutual funds

A mutual fund is a pool of money managed by a professional fund manager. It is a trust that collects money from several investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities. The returns or profits from this collaborative investment are distributed to investors in accordance with their contributions following the deductibility of applicable fees and charges. This is done by computing the ‘Net Asset Value’ (NAV) of the plan. A mutual fund's worth is essentially derived from the total amount of money given by all its investors. Simply, a mutual fund is the sum of the money contributed by numerous individuals.

At the heart of their operation, mutual funds serve as conduits for pooling funds from investors and deploying them across a spectrum of financial instruments, including stocks, bonds, and money market securities. By integrating resources from a broad spectrum of investors with varied investment objectives, mutual funds democratise investing. This enables even small investors to benefit from professional fund management and diversification, which may be challenging to achieve individually.

Mutual funds as financial intermediaries

Financial intermediaries play a vital role in connecting borrowers and lenders within an economy. They accept funds from savers and allocate them to borrowers, facilitating the flow of capital. Mutual funds function as one such intermediary, pooling money from various investors to capitalise in a diversified portfolio of assets such as stocks, bonds, and money market instruments. A financial intermediary serves as a go-between for parties involved in financial transactions, such as a commercial bank, investment bank, mutual fund, or pension fund. These entities offer several advantages to regular consumers, including security, accessibility to funds and cost efficiencies in banking and asset management. By facilitating transactions, financial intermediaries contribute to creating efficient markets and reducing business costs. They can also offer services like leasing and factoring, but they do not take deposits from the general public. Financial intermediaries help distribute risk, lower expenses, and provide scale efficiencies, among other benefits.

Mutual funds offer active management of pooled capital contributed by investors. The fund manager invests the capital in stocks of companies that are expected to perform better than the market. This process allows the manager to provide investors with assets, companies with capital and the market with liquidity. Savers can combine their funds through a financial intermediary, allowing them to make significant investments that benefit the target entity. Additionally, financial intermediaries help distribute risk by diversifying funds across various investments and loans.

FinTech fusion

The digital revolution also played a pivotal role in shaping investor behaviour, particularly among younger generations. Millennials and Gen Z investors, known for their tech-savvy nature, are increasingly turning to online platforms and mobile apps to invest in mutual funds. The convenience, accessibility and user-friendly interfaces of digital investment platforms have democratised investing, making it accessible to a wide segment of the population. Moreover, COVID-19 accelerated certain trends in investor behaviour, such as the adoption of digital channels for investment transactions and focus on financial planning and risk management. The uncertainties brought about by the pandemic have underscored the importance of maintaining a well-diversified investment portfolio and adopting a disciplined approach to long-term wealth creation, driving investors towards mutual funds.

The integration of technology within the mutual fund industry in India significantly accelerated innovation and growth. Fintech fusion revolutionised the sector by streamlining operations, enhancing customer experience, and expanding access to investment opportunities. With seamless online transactions, real-time monitoring, and personalized financial advice, fintech has made investing convenient and inclusive for a broader audience. The transformative impact of fintech in the Indian mutual fund industry not only modernised traditional processes but also catalysed the industry's evolution towards a more efficient, customer-focused, and technologically advanced landscape.

The digital integration in mutual fund operations has brought about a paradigm shift in how investments are made and managed. By leveraging technology, mutual fund companies can offer investors a user-friendly platform to invest, redeem and track their investments seamlessly. This digital transformation eliminated the need for physical paperwork, reduced transaction times and enhanced overall efficiency in managing investment portfolios. Investors now have easy access to real-time information, enabling them to make informed decisions and manage their investments effectively. The significant increase in digital transactions from 1% to 21% of the total transaction value over the decade underscores the growing preference for digital channels in mutual fund investments among investors, especially the younger demographic. This shift towards digital investing signifies a broader trend towards technological advancement and accessibility in the mutual fund industry, shaping an inclusive and tech-savvy investment landscape for all types of investors.

Fintech companies have played a pivotal role in reshaping the investment landscape in India by introducing innovative investment products and services, personalised financial advice, and intuitive interfaces that cater to the diverse needs of investors. The democratisation of investment opportunities through fintech solutions has made investing more accessible to a wider audience, empowering individuals from various backgrounds to participate in the financial markets and build wealth over time. FinTech’s have emerged as the primary distributors of mutual funds in India, mirroring the success observed in the online stock-broking sector, similar to companies like Zerodha. Notably, Groww, AngelOne and PhonePe are key players in the industry, contributing significantly to the addition of new SIPs every month.

In November 2023 alone, Groww issued over seven lakh new SIPs, while AngelOne and PhonePe generated more than two lakh and over a lakh new SIPs, respectively. Data from asset management companies, shared with ET and AMFI, indicated that in November 2023, the entire industry generated 30 lakh new SIPs, with approximately 42% of these being issued through fintech platforms like Groww, Paytm Money, AngelOne, among others. The AMFI noted that over 3 million new SIPs were created in November 2023, of which around 1.3 million were opened on fintech platforms, according to industry estimates. Traditional entities in this field, such as NJWealth and State Bank of India, are also actively generating new SIPs, both issuing more than a lakh per month. In contrast, banks like HDFC, ICICI and Axis created between 30,000 and 50,000 new SIPs. Fintech firms leverage their distribution capabilities to capture market share in wealth management. For instance, PhonePe uses its extensive user base from its payments service to provide mutual funds’ investments as an additional service to retain users. Alternatively, Groww uses mutual funds as a means to attract investors to eventually participate directly in the equities market. The digital transformation in mutual fund operations supported this trend, with fintech platforms offering smooth online transactions and real-time monitoring to enhance the investing experience for a broad audience.

The emergence of new-age startups in the mutual fund space fuelled innovation within the industry by leveraging cutting-edge technologies such as data analytics and artificial intelligence to develop unique investment solutions like robo-advisory platforms and thematic investing strategies. By focusing on customer-centricity and enhancing user experience, these startups redefined the mutual fund landscape in India, offering investors innovative ways to diversify their portfolios and achieve their financial goals.

Ease of investing driving higher penetration

Mutual funds have indeed emerged as significant economic catalysts in India, driving growth within the capital markets. They not only provide investors with diversified investment options but also play a crucial role in channelling savings into productive investments. By pooling funds from individual and institutional investors, mutual funds create a substantial corpus that can be invested across various asset classes, fuelling economic expansion. With a diversified portfolio of securities, mutual funds offer investors the opportunity to earn potentially high returns and minimise risk. The ease of investing and professional management provided by mutual fund companies contributed to the growth of AUM in the mutual fund industry. Moreover, mutual funds offer different types of schemes catering to various investment objectives and risk profiles. Investing in mutual funds provides individuals with access to a wide range of financial instruments such as stocks, bonds, and money market instruments. This diversification helps mitigate risks associated with investing solely in individual securities. Additionally, mutual funds allow for flexibility in terms of investment amount and frequency.

A noteworthy trend emerged as investors substantially increased in states like Bihar (+42% YoY) and Uttar Pradesh (+41% YoY), underscoring the growing participation of smaller towns in the investment landscape. This trend highlights the expanding reach of mutual funds into previously untapped regions, bringing investment opportunities to a broader segment of the population, including those in rural areas. The increasing participation of retail investors, including those from smaller towns in states like Bihar and Uttar Pradesh, showcases the democratization of investing facilitated by mutual funds. This broader access to professionally managed portfolios across different sectors and securities fosters financial inclusion and deepens the investor base, contributing to the growth and dynamism of India's capital markets. One of the most positive changes observed in the mutual fund industry is the increase in retail investor participation. As per the data reported by AMFI for December 2023, individual investors held 60.1% of assets, compared to 57.8% in December 2022. Institutional investors account for 39.9% of assets, with corporates holding 96%, while the remaining portion is held by Indian and foreign institutions and banks. Equity-oriented schemes exhibit an interesting trend, with 89% of their assets sourced from individual investors (retail + HNIs). Conversely, certain schemes are predominantly influenced by institutional investors, with institutions controlling 90% of assets in fund of funds and 86% in money market schemes.

Additionally, mutual funds enhance market liquidity and efficiency by actively trading in financial markets, contributing to price discovery and fair value trading of securities. This liquidity attracts more investors to the market, boosting market activity and fostering healthy competition.

Furthermore, mutual funds' role in investing in startups and emerging companies through venture capital funds promotes innovation, entrepreneurship, and job creation, driving economic progress and technological advancements. In conclusion, mutual funds are vital drivers of economic development in India's capital markets, mobilising savings, promoting financial inclusion, enhancing market efficiency, fostering innovation, and supporting sustainable development. As mutual funds continue to evolve and expand their reach into previously underserved regions like Bihar and Uttar Pradesh, they are poised to be increasingly crucial in shaping India's financial landscape and driving long-term economic growth.