Address by WTM (Shri Ananth Narayan G) - 16th Mutual Fund Summit (ASSOCHAM) - Unlocking the Potential: Exploring Investment Opportunities for Viksit Bharat

Address by Shri Ananth Narayan G, WTM SEBI 16th Mutual Fund Summit (ASSOCHAM) “Unlocking the Potential: Exploring Investment Opportunities for Viksit Bharat” August 09, 2024 I thank ASSOCHAM for giving me this opportunity to deliver the inaugural address at your 16th Mutual Fund Summit. I am here on behalf of my fellow Whole Time Member Amarjeet Singh, Executive Director Manoj Kumar, and the excellent team at SEBI’s Investment Management Department that oversees the Mutual Fund industry. I thought I would take this opportunity to offer some personal reflections on the very impressive journey of the Mutual Fund industry over the years, reflect on some of the risks that perhaps warrant attention from all stakeholders, and finally, refer to some of the exciting initiatives being undertaken by SEBI and the MF ecosystem for the days ahead. Take a bow The MF industry has made impressive strides over the last few years and is now playing a most crucial role in channelling financial savings towards risk capital formation. While stable macros, increased formalization, robust corporate earnings, digitization and user-friendly access likely laid the foundation, the MF ecosystem for its part has stepped up remarkably well to earn the trust and garner the savings of an increasing number of Indians. From less than 2 crore unique investors as of March 2019, the industry had grown to nearly 4.7 crore unique investors as of June 2024 - an impressive CAGR of 18% during this period. Since March 2019, MFs have net garnered, on average, nearly INR 2.4 lakh crores each year from their investors. Of this, more than INR 2.2 lakh crores have been directed towards risk- oriented schemes – i.e., equity-oriented schemes, hybrid schemes, equity-oriented ETFs, and Index Funds. In comparison, the average FPI inflow into equities over the during the same period since March 2019 was INR 61k crores per year – less than a third of the MF flow. The MF flow momentum has only gathered further pace in the last three years. The average annual MF flows into risk-oriented schemes over the last three years has risen to INR 3.3 lakh crores per year now. There can be little argument that these robust MF flows, backed by strong earnings and stable macros, and have contributed to the strong and steady performance of the Indian markets during this period. As an illustration, over the last 3 years, our benchmark indices have given a creditable return of 14% CAGR, with an annualized realized volatility of just 14.3%. Compared to major global markets, at least for this period, this represents higher return and lower volatility. As an 1example, during this period, the Nasdaq Composite has given a lower return of 3.7% CAGR, with a higher volatility of 23.5%. On the back of these robust inflows and market price growth, MF AUM has grown from INR 23.8 lakh crores as of March 2019, to INR 61.2 lakh crores as of June 2024, an impressive CAGR of 20% per annum. The entire MF ecosystem - from the AMCs, distributors, their support partners, regulators, media and analysts, and the investors - should take a bow. Risks to Ponder Having said that, there is no room for any complacency. There are plenty of opportunities to grasp, and corresponding risks to recognize and manage. There are over 55 crore people who have their PAN numbers linked with AADHAR – one could argue that they are all potential candidates to becomes part of the securities market ecosystem. However, our role as a composite securities market ecosystem is to ensure all-round balance and sustainability. While growth in investor participation aids capital formation, we are also duty bound to ensure that their investments – held by the MF ecosystem in trust - are managed responsibly, and that investors are both completely aware of, and accepting of, the inevitable risks that accompany securities markets. The fiduciary responsibilities of the MF industry should well outweigh any commercial goals and considerations. To paraphrase what the eternal poet and philosopher Rahim said in one his outstanding couplets, the best time to reflect on possible issues is during good times rather than bad. In this regard, here are some personal reflections on areas that warrant some study and debate. Mismatch Between Demand & Supply I have spoken earlier about the need for some balance between the supply of fresh securities and the demand for paper. Between FY17 and FY21, the demand for paper in secondary markets, across MFs, DIIs, individuals, and FPIs averaged INR 23k per year. Since FY22, that number has risen by over 5 times to average INR 126k per year. Seen another way, in FY24 alone, the net demand for paper – across primary and secondary markets, from all MFs, DIIs, individuals, and FPIs, stood at around INR 3.6 lakh crores. Against this, the supply of fresh paper in FY24 – across IPO, FPO, Rights Issue, QIP, Preferential Allotment was less than INR 2 lakh crores. This mismatch has only grown in recent times. Of course, for every buyer there must be a seller. But ideally, one would like to see fresh paper issued by companies – rather than substantially the same paper being churned - to meet the demand for paper from core investors such as individuals, MFs, DIIs, and FPIs. Fresh paper issuance is clearly a better reflection of fresh capital formation and raises less doubts about asset price inflation. Over the past 5 years, over 40% of all midcap, smallcap, and microcap stocks have grown by over 5 times in price. While earnings growth, macros, and any other number of factors can be 2used to explain and justify price movements, I would urge the experts in the industry – as fiduciary managers of people’s money – to collectively deliberate this issue. I also note that some large fund houses have proactively stopped lump-sum investments in some small-cap schemes, and capped the amount that can invested via SIPs. Stress Tests As a result of the large inflows from individual investors into equity capital markets in recent times, the holdings of MFs, DIIs and individuals have inevitably risen as a percentage of free float in most companies over the past 5 years. As an example, the holdings of MFs, DIIs, and individuals have risen from 54.3% of the free float of all midcap and smallcap companies as of March 2020, to 60.6% as of March 2024. This does raise questions about what would happen in the hypothetical stress event of large redemptions from mutual funds, particularly from arguably less-liquid midcap and smallcap schemes. To help address this question, MFs conducted their own stress tests of their individual schemes and made the results of such tests public. While individual stress tests are useful to describe idiosyncratic risks of redemptions from one scheme or one fund house, to capture system wide risk, it is also important to model stress scenarios for the entire composite MF ecosystem. SEBI’s research team has done some preliminary analysis on this score – by considering how many days it would take for all equity mutual funds to cater to say a hypothetical sudden and large 10% or 20% redemption over a short period of time, given extant levels of average daily delivery volumes in the secondary markets. While SEBI’s findings will be reviewed and published shortly, the preliminary findings are somewhat encouraging, with some caveats. The initial findings suggest that despite the substantial increase in MF holdings of stocks over time, the number of days to cater to a hypothetical sudden 10-20% redemption have not really changed between say March 2020 and March 2024. There are of course, caveats that need to be kept in mind. Secondary market turnover and average daily delivery volumes have increased substantially over the past few years – and this accounts for why the number of days to reduce MF positions hasn’t really changed over time. A moot question could well be if secondary markets would be as welcoming of supply of paper by Mutual Funds during a stress period, as they have been of demand for paper during good times. An inevitable follow- on question would be around the market price impact of such a hypothetical event. In any case, I would strongly encourage the industry and AMFI to take the lead and proactively conduct objective and credible industry-wide stress tests themselves. Needless to add, stress tests of this kind are a core part of risk management for any financial sector ecosystem and help strengthen the ecosystem. Separately and more broadly, we perhaps need to explore better ways of conveying the risk of different mutual fund schemes better. While the existing risk-o-meter is simple and a dramatic improvement over the earlier one, it perhaps does not adequately differentiate between the risks of the many types of schemes that are on offer today. While ensuring 3simplicity and ease of understanding remains a key objective, perhaps the underlying volatility of portfolio, and the liquidity of the portfolio from the stress tests, could be used to provide better color all around. Given the crucial need to convey risks clearly to investors, as a former academic, I would strongly urge the industry to deliberate this issue. Investor Suitability & Appropriateness, and MF Distribution Mutual Fund Distributors (or MFDs) have played a creditable and pivotal role in the impressive growth of the Mutual Funds ecosystem over the years. As on date, there are over 1.6 lakh MFDs holding AMFI Registration Numbers (ARNs), who have helped spread the good word far and wide, across several PIN codes of the country. As you are aware, SEBI does not regulate MFDs directly – from our perspective, MFDs are a part and extension of the MF industry. As such, MFs are responsible for the activities of the MFDs. Oversight here is crucial, since ensuring client suitability and appropriateness, investor risk awareness and education, and guarding against any mis-selling is a critical part of ensuring sustained business growth and capital formation. Given that MFDs are paid by the producers – i.e., the MFs – and not the investor, there is a special need to ensure that the investors best interests are not just always protected but are also seen to be protected. It was worrisome to hear of some wealth managers running internal campaigns – with sales incentives given by the MFDs - to push specific products that offer them higher distribution fees; something that AMFI has recently tried to address. Even while sterling work has been done by the ecosystem so far, I would suggest that there is a constant need to review and debate how investor best interest can always be protected, especially since we have a long way to go on increasing the investor base. Separately, you have also seen the recent steps announced by SEBI to try and expand the base of Investment Advisors in the country – entities that are paid by the investor rather than the industry - and therefore whose earnings are at least optically better aligned to the outcomes of their investors. Positive initiatives - anvil I would like to end on a positive note – befitting an industry that has delivered remarkably over the past many years, and in many ways, an industry that is the flagship of our securities market ecosystem. Over the years, notwithstanding the robust discussions that we sometimes have as the regulator and the regulated, the MF industry and its members have increasingly become our trusted partners. Reflecting this trust and dialog, there are several exciting initiatives on the anvil, that have been co-created by all stakeholders. 4The proposed introduction of MF Lite Regulations will offer light-touch regulation for passively managed funds, reducing their compliance burden and fostering competition and innovation. The proposed introduction of a new class of schemes, that run higher risk that than of the regular MF schemes and are on offer to investors with somewhat higher risk capacity, understanding, and acceptance, is another exciting innovation on the anvil. At a time when we are trying to discourage individual participation in high-risk pockets such trading in index options closer to expiry, we are simultaneously trying to offer better avenues and vehicles for self-aware investors to assume higher risks in a better manner. Once again, this reflects our confidence that the MF ecosystem are responsible partners in the journey to capital formation. The proposed low-ticket SIP and further sachetization and tokenization of regular SIPs is another exciting prospect for furthering financial inclusion while ensuring responsible investing. Some asks. I suggest that the industry can do further work on streamlining operations and improving efficiency for our investors. At a time when instantaneous funds transfers have become ubiquitous in our country, perhaps we should look to improve our internal processes and the securities settlement ecosystem to ensure that funds are passed on to investors on the day of the settlement itself, rather than a day after. Finally, as knowledgeable and respected ambassadors of the capital market ecosystem, we need the MF stalwarts to remain trusted partners in both market development and in market regulation. With your eyes and ears to the ground, we look upon you to say something, if you see something. Congratulations once again on the journey so far, and I have no doubt that you will continue to deliver on responsible financial inclusion into our securities market ecosystem, furthering the cause of sustained capital formation. Once again, thank you to Assocham, and thank you all for your patient hearing. ***** 5