Falling inflows into mutual funds warrant concern

The sharp decline in flows into equity schemes of mutual funds may have rattled many, but this is not entirely surprising. Stock prices in India have been soaring without any fundamental backing for some time now, driven purely by the incessant demand from mutual funds and pension schemes. With the macro data painting a very grim picture for the coming quarters and corporate earnings continuing to stutter, investors have reasons to be worried about the elevated levels at which stocks are trading. While the flows into equity mutual funds, close to ₹1,000 crore in November this year, is the lowest since June 2016, average monthly flows have been contracting for some time now; down to ₹6,000 crore this calendar from around ₹9,000 crore in 2018 and ₹12,000 crore in 2017. It is evident that the smarter investors have turned wary of investing further into equities, given the pricey valuation of large cap stocks and the governance risk in smaller stocks.

Reduction in flows is not good for the stability of the stock market, as mutual fund flows had helped buttress stock prices over the last five years, even as foreign portfolio flows contracted as a consequence of global central banks tightening their monetary policies. While prior to 2014, FPIs had been the most dominant category of investors, influencing stock price movement, this had changed since 2015, when MF investment in equity market was ₹69,936 crore, against ₹18,608 crore invested by FPIs. This trend continued in 2016, and peaked in 2017 following the demonetisation, when MFs invested ₹1,17,675 crore in the equity market — double the sum invested by FPIs that year. If mutual funds reduce their investments in stocks as a consequence of lower inflows into equity schemes, the stock market will once again be exposed to volatility risk caused by foreign fund flows. This data also implies that retail investors are beginning to get disillusioned with investments in stocks; equity schemes derive 87 per cent of their assets from individual investors, including high networth individuals. Also, with 64 per cent of assets from B30 locations being invested in equity schemes, this could also indicate that investors from smaller towns are beginning to cash out. However, the continued inflow into SIPs, which clocked ₹8,273 crore in November, is a good sign.

There isn’t much that the regulator can do to influence such flows, which tend to be cyclical, ebbing and rising with investor perception of growth. That said, it is imperative that smaller investors are made aware of the risks they are taking while investing in equity mutual funds. The regulator should deal with instances of misselling mutual funds as guaranteed return or fixed return products very strictly. It is due to a lack of awareness and unrealistic return expectations that investors tend to get disappointed and stop investing in stocks or mutual funds altogether. Mutual funds should also be nudged to launch more passive investing products, such as index funds and exchange traded funds.