From the newsletter “The Honest Truth” from EquityMaster.

On August 1st, 2009 the Indian mutual fund industry enters a new era.

After years of pushing mostly irrelevant products through a distribution channel that grew fat on the ignorance of investors, the Indian mutual fund industry has been forced to lay bare the facts. From August 1, 2009 all Indian mutual funds will have a cap on what they pay their distributors.

And investors can pay their distributors and financial advisors what they believe to be the value of the advice given.

Over the years, the elephants in the Indian mutual fund industry – and the distributors that made these elephants dance to their tune – have spread a series of questionable “facts”.

Each “fact” was in many ways designed to support the immoral practice of letting commissions earned by many distributors determine which mutual funds they recommended. Funds were sold based on the commission structures paid to distributors, not based on which funds were best suited for the investors.

The elephants in the mutual fund were happy to dance along to the tune of many distributors. Every time a fund was sold (or mis-sold) it meant a larger “total assets under management” for the industry – and more fees for the mutual fund house. And better salaries and bonuses for all in the system.

Now, the mutual fund industry is in new territory, not because the giants chose to take the side of the good and right (in fact, they fought it) but because the regulator put a stop to the rot. The days of the symbiotic relationship between the elephants and the distributors are over.

From August 1st the mutual fund industry has to learn to focus on what is good for the investor. A new playing field for those not used to it. So many in the mutual fund industry stand at the gate, nervous and anxious.

However, there is already an AMC, Quantum Mutual Funds which does not pay commissions to any distributors because they were alarmed at the scope for mis-selling in the industry.

More power to these guys.

CRISIL reports that Diversified Equity funds, on an average, out-performed the S&P CNX Nifty and Sensex in the month of August led by the out-performance of midcap stocks vis-à-vis large caps. As most diversified equity funds have a fair exposure to midcap stocks, this has helped them boost their returns in August.

In addition, the out-performance is a result of auto, banking, IT and FMCG stocks doing well in the month. 237 schemes out of 335 schemes in the equity fund category, outperformed the S&P CNX Nifty in August. Top performers in the category belonged to ELSS schemes as well as general equity schemes. Franklin India Taxshield 99, Fidelity India Special Situations Fund and Lotus India Midcap Fund were the top three gainers.

All CRISIL indices posted positive returns in August. Equity based indices lead the charts when analyzed forthe month as a whole. The hybrid CRISIL Fund~bX (which tracks balanced funds) surged the most during the month by 2.83 per cent, benefiting from the good showing of both equities and debt. This was a classic case of benefits being derived from diversification into debt and equity as for some periods in the month positive movements on the debt side cushioned negative movements on the equity side, thus causing balanced funds to out-perform equity funds on an average for the month taken as a whole. The CRISIL Fund~eX (which tracks equity funds) closely followed it with 2.49 per cent returns while the CRISIL MIPEX, (benchmark for monthly income plans) which has a lower equity component, posted a return of 0.79 per cent. Among pure debt indices, CRISIL Fund~ Gilt Index (benchmark for Gilt Funds) rose over 1 per cent while CRISIL Fund~dX (which tracks Long-Term Bond Funds) ended up 0.75 per cent. The CRISIL STBEX (benchmark for Short-Term Bond Funds) rose 0.68 per cent and CRISIL~LX (which tracks liquid funds) gave a monthly return of 0.71 per cent

Auto and Banking Sector stocks provide a kicker in the equity funds category

“Among the key outperforming sectors were interest rate sensitive sectors such as auto and banking which topped the returns chart on hopes of softening interest rates as inflation showed signs of easing.” Availability of stocks at good valuations given the hammering these sectors have taken in the past also contributed to the uptick. Adds Mr. Sitaraman, “Easing of inflation worries also helped the FMCG stocks do well while the depreciating rupee helped ITstocks outperform during the month.”

JM Auto Sector Fund was the top performer in the equity category with 9 per cent return. Lotus India Banking Fund followed it with 7 per cent returns over the past month. Franklin Infotech Fund gained over 6 per cent while UTI-Software Fund returned 5 per cent during the month.

Reliance Industries Ltd. continued to be the most popular stock among fund managers of diversified equity schemes over a 3-month time frame followed by Bharti Televentures Ltd and Larsen & Toubro Ltd. Among industries, the banking sector continued to be the most sought after industry for yet another month followed by Computers – Software, Electrical Equipment and Pharmaceuticals..

Indian mutual fund industry’s average assets under management (AUM) rose by nearly 3 per cent in August, to Rs.5.45 trillion from Rs. 5.31 trillion in July 2008 (including fund of funds). The rise in average AUM can be attributed to the resurgent equity market as well as new fund offerings in Fixed Maturity Plans (FMPs). 25 out of 34 fund houses witnessed rise in their average AUM. Reliance Mutual Fund continued to dominate the asset charts with an average asset base of Rs 886 bn, up by almost 5 per cent from the previous month. HDFC Mutual Fund moved up by one notch to occupy the second spot. Its average assets under management rose by 6 per cent to Rs 539 bn.

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