The last 3 years has seen a push by SEBI towards direct mutual funds, and away from regular mutual funds. For investors who have had the time and inclination to learn about the difference between these two types of funds (direct funds have no sales commission attached to them, and have lower expense ratios as a result), the switch to direct funds has allowed them to save on the sales commissions paid to distributors and brokers by the fund houses.
SEBI’s push has also been accompanied by the move towards digitization of mutual fund investing - a service aimed at replacing the traditional method where salespeople came to individuals’ houses with a pen and paper and promises of great wealth. People would sign up for a fund, the salesperson would receive a commission for the lifetime of that fund from the mutual fund house, and the investor would usually be none the wiser.
Those in favor of digitization spoke about the convenience of investing online, envisioning a world where the sale or purchase of a fund would be as easy as shopping on Amazon or Flipkart. It would also, they argued, increase transparency to the investor.
Entrepreneurs duly responded to this call, creating platforms and systems that would enable investors to buy mutual funds online. Today, the list of such platforms is large enough that we’ve written an entire blog post about it.
The most obvious advantage of these platforms is that they are easy to use, easy to look at, and are consumer-friendly. They are also helping increase personal finance literacy by equipping investors with the tools that they need to make direct investments. As far as entrepreneurs and Venture Capital firms go, the pitch for funding these ventures makes sense: even though there are only 20 million investors in India today, there is unlimited potential for tomorrow and the Indian markets are set to grow steadily in the future.
Nevertheless, I can’t help but wonder if any of these companies will survive.
The first reason for doubt is that there is far less money to be made from selling direct funds than regular funds. The difference in expense ratios between direct funds and regular ranges from 0.5% to 2% of the fund. Assuming that a large part of that difference is paid out as a sales commission to the distributor, we can see that they’d make 0.5% to 2% in fees by selling a regular mutual fund. On the other hand, the direct platforms that charge as a percentage of portfolio charge much smaller amounts - usually under 1%.
It can be argued here that the business model of the platforms is not the same as the distributor model, making such a comparison unfair, and that scaling a website is easier than a distribution business, which means that these platforms could make a lot more money by engaging a large user base.
This is true, but competition in this space is brutal, and differentiation is very difficult, driving prices to low, often unsustainable amounts. All the platforms offer the exact same funds; many of their homepages have similar infographics about the advantages of direct over regular mutual funds. In fact, the underlying technology is the same for most of them - they either use the BSE Star APIs or the MFUtilities platform to execute orders, Buying a Birla fund on Piggy is the same as buying it on WealthTrust - the only difference between the two is the color of the UI. This competition pushes prices and profitability to zero.
The space hasn’t seen meaningful product differentiation either. Many of the direct investment platforms provide Robo-advisory services - algorithms that generate customised portfolio suggestions based on criteria entered by a user (such as age, salary, financial goals). This is mostly meaningless; the fact that one can build a robo-advisor using an excel spreadsheet should indicate how trivial the “advice” is. The advice is rarely tailored for the individual’s risk tolerance or financial needs. Robo-advisors do, however, work well for people who are young and have little money (namely, freshly minted millennials). It works for them because allocating the portfolio is simple for someone who is young with a stable income - put a 100% in equity funds, and just pick the best performers.
But young people don’t have much money to invest with in the first place. The vast majority of AUM for mutual funds comes from older folks, who have had more time to save (and compound) their wealth. Their financial needs are typically more nuanced and require more strategic and timely planning. Even though technology can greatly help with this, an experienced human’s discerning eye is still required. It’s fascinating to see that Betterment (a major robo-advisor in the US) now offers access to human financial advisors. There’s no hard evidence to suggest this, but I suspect that they’re running into the stumbling block of automated advice not working for anyone except the smallest customers.
Finally, natural viral growth channels are hard to come by in the investing space. By nature, investing is a private activity and you’re unlikely to get value out of sharing your investment details with other people.
For these reasons, I think a brand, not a product, will win the investing platform space. It’s a bit of a wildcard entry, but I think PayTM has the best shot to doing it. They don’t need to make money off the space, and they have great brand recognition.
But on the other hand, what if all the standalone direct platforms go out of business? The cost of integration with other technology platforms (such as the BSE Star API) and other overhead costs means that profit margins are very low (and sometimes negative). Many of these platforms are backed by venture capital funding, and one day, that tap might dry up. This could result in a shift away from direct investment platforms. More DIY investors will make their investments directly with the AMCs or MFUtilities. Advising services might remain as is today - many people will go through IFAs, while some will be willing to pay a consultant fee to RIAs for the planning and for the transparent fee structure.
Intuitively, selling mutual funds seems like a great business opportunity. After all, the Total Addressable Market (TAM) is quite large and is growing. The Economic Survey of India released this week stated that there has been an 11-fold increase in mutual fund savings over 2 years. That’s unprecedented, and the number will likely grow. And as the market grows, technological requirements will increase, broadening the marketplace for technological services. But it seems like creating a product to address the need is not profitable right now, at least not on its own. Diversification of product offering and brand value will likely define who becomes successful and profitable.
Track your mutual funds automatically at SimpleMoney.