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Fintech Startups in India Await SEBI Approval to Become Mutual Fund AMCs

Jan 28, 2022 1:31 PM 6 min read

After months of speculation, PhonePe has joined a growing list of fintech enterprises awaiting SEBI's approval to set up their own asset management companies (AMCs).

PhonePe’s application follows the market regulator’s relaxed rules on setting up AMCs, which it notified in 2020 “to facilitate innovation and enhanced reach”. 

From Fund Distributors to Fund Managers

The Walmart-owned payments platform is not alone in its mutual fund bid: Zerodha is planning to launch its own schemes this year. Niyo and Groww are eyeing the space as well.

Many other new and established players alike are looking to launch fresh schemes in the near-term. These include Bajaj Finserv, Navi Technologies, Samco, Angel One, Old Bridge Capital Management, PB Fintech and Helios Capital Management PTE.

Fintech firms foraying into financial services is but a natural and explicable leap. PhonePe, for instance, entered the space way back in 2017 when it began allowing users to buy gold as an investment. Its peers, from Paytm and Kuvera to Zerodha and Groww, are already dabbling in wealth management products.

That said, these companies' entry into the ₹38Lcr ($505.84bn) mutual fund industry as AMC managers as opposed to mere distributors is a big deal. Not only for these new-age tech startups themselves searching for a piece of the pie, but also for the mutual industry at large…


The Indian Mutual Fund Industry: A Brief Overview

Currently, the country has 45 AMCs and about 1,500 schemes across the debt, equity, hybrid, ELSS and ETF segments. As of August 2021, the Assets Under Management (AUM) of these schemes stood at ₹36.59Lcr ($473.76bn).

FYI: If you're new to the world of mutual fund investing, you may want to check our 10-point beginners' guide. Also, watch out for those pesky hidden costs!

The securities market penetration in India is woefully limited, at just 6.5%, and concentrated in rich and educated pockets of big cities. By comparison, this number for the US was 55% (in 2020).

Clearly, the segment is dismally untapped. Which is a concern SEBI may have had in mind in late 2020, when the regulator relaxed rules for new entities with “tech-enabled solutions” to set up AMCs. While it did stipulate fresh conditions - such as the requirement for ₹100cr ($13.31m) in net worth - it removed the requirement for five years' experience in financial services, practically opening the door for a slew of new players.

Today, the street view seems to be that fintech could do for mutual funds what discount brokerage did for market trading. Which is, essentially, democratise access and modernise a still-underpenetrated market.


New Kid in the MF Block

But why are fintech firms gravitating towards managing mutual funds in the first place?

One reason may be that the industry itself is growing rapidly (as we've seen above), and these players want to capitalise on this growth.

The second reason may be that the COVID-driven boom in stock market investing may be running out of fuel as the economy returns to some level of normalcy (Omicron notwithstanding). Investor appetite for DIY investments may be diminishing; as such, mutual funds offer a novel way to still leverage on growing financialisation of savings and bet on the surging retail investor base.

The third factor may be the low margins and high customer acquisition costs (CAC) in the hypercompetitive and cut-throat fintech and wealthtech space, which have made breaking even without diversification a somewhat arduous task. Through this lens, the shift from being fund distributors to mutual fund operators is a market + margin expansion play, which then becomes more a question of when than why.


Fintech in the Fray

Fintech firms are already making a mark in the industry. The AUM of fintech distributors jumped 2.4x between FY20 and FY21 in the equity segment to ₹27,463cr ($3.66bn). During this period, SIP registrations also increased 60% while debt AUM more than doubled to ₹5,099cr ($678.76m).

Once these players begin rolling out their own schemes, ceteris paribus, one may expect these numbers to jump further up.

What’s catalysing the fintech growth in the mutual fund segment? In large part, the same drivers that have been bolstering Indian markets over the past few years: (1) increased digitisation and (2) an influx of young and newbie investors.


The Times They Are A-Changin’

Financial technology platforms are naturally very internet-savvy and geared towards gadget-friendly customers. Many of them also support robo-advisory functionalities, offer schemes from many fund houses, provide investing-reated explainers and guidance, and charge low or no commissions (at least on direct plans and at least for now).

Then there is the nature of their target customer base: young, aspiring investors from the ballooning middle class. These “Robinhood” traders, fuelled by the discount brokerage boom, eagerness to make a quick buck and sheer pandemic-induced stuck-at-home boredom, have changed the very nature of Indian markets over the past two years. In doing so, they have contributed to a relentless stock market rally and the biggest IPO year in market history.

(Whether they are also partly to blame for mushroomed valuations and enhanced market volatility, though, is a different debate. That said, increased retail participation in a stock market that used to be overwhelmingly driven by HNIs and corporates is a welcome trend.)

Now, for the new investor, stock marketing investing may be a daunting proposition, given the complications and risks involved. Mutual fund investing, on the hand, is safer, easier, and less hands-on. Plus, with relatively more surety of returns.

All said and done, if you’re a young, enterprising individual who spends most of their time online, investing via fintech platforms would be a more relatable experience vis-a-vis browsing or dialling up traditional AMCs and brokers.

FYI: Significantly, fintechs’ participation in the mutual fund space has been accompanied by an explosive expansion of the fintech sector itself. As of June-end, there were reportedly 2,174 fintech startups in the country. That’s up from just 454 in 2015.


Risk, Thy Name is Investing

Obviously, investing is risky business, regardless of whether you do it via traditional brokers or an Android app. Especially so for the fledgling investor, who may have entered the game during the 2020-21 bull run (and now may be getting too comfortable in a possible bubble). Markets are fickle things, and, unless dealt with cautiously, the costs of tardiness or ill fortune can be, well, costly.

Fintech mutual fund investing carries many of the same risks of the traditional kind, such as financial data security and hidden costs. Also, most of these fintech firms have been around for only a few years - their future prospects are, for lack of a better phrase, “subject to market risks”.

It should also be noted that original/personal research is paramount: recommendations by influencers should not be taken at face value + a robo-advisor is only as good as the algorithm it is based on. Don’t get lured by buzzwords like "Big Data analytics", "machine learning" or "artificial intelligence".


The Bottom Line

Fintech-issued mutual fund schemes are the quintessential technological solutions for a tech-savvy generation. The segment is new, exciting and promising. Case in point: over the past fiscal, even while equity funds witnessed net outflows, fintech players continued to enjoy a surge in assets.

It is also a still-evolving scene. New funds seem biased towards passive investing (i.e., where a scheme tracks a market index). This may be because such schemes are easier-to-understand, easier-to-manage and easier-to-sell. They also have lower operating expenses, justifying low total expense ratios (TERs). As regulations and participation catch up and the sector matures, more fund diversification may be in the offing.

FYI: It might also be interesting to see if this new trend will evoke an antitrust response. After all, if and when Zerodha issues its own schemes, they would share space with other non-Zerodha schemes on…Zerodha. Essentially, a distributor is marketing its own products alongside its competitors’. Amazon infamously tried that, and regulators were more than unimpressed.


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