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Why are equity mutual funds becoming highly popular in India

05 Jan 2023

The recent data put out by the Association of Mutual Funds of India (AMFI) records a sharp increase in the number of folios of mutual funds. Folios record the unique mutual fund accounts and not the unique mutual fund investors. That means an individual can have, and usually does have, multiple folios. However, the growth in folios is broadly indicative of the retail interest in mutual funds; especially equity funds. Let us look at the data! For the calendar year 2017, mutual funds added a total of 1.37 crore new folios taking the total folios in India to 6.65 crore. Out of these, a large chunk of folio accretion has happened in equity funds, ELSS funds and balanced funds which broadly indicate retail appetite. In fact this is reflected in the investment of Indian mutual funds in the equity markets and their inflows have far outpaced that of FPIs. Let us look at the MF flows into equity markets in the last one year.

Mutual fund flows into equities in 2017

                                        Source: Moneycontrol

As can be seen above the above chart, the cumulative MF investment during the year has been consistently going up each month and MFs have infused a total of Rs.117,000 crore during the full year 2017. That is more than twice the amount of Rs.49,000 crore infused by FPIs during the full year. What explains this sharp surge in MF inflows into equities? The answer obviously lies in the fact that equity fund collections have zoomed sharply during the year with most of the funds coming through retail collections and principally through the SIP route. In fact, in amount terms nearly 40% of the total mutual fund inflows came into equity funds, ELSS and balanced funds representing the retail appetite for equity funds as an asset class. That brings us back to the fundamental question as to why are retail investors getting attracted to equity funds?

6 reasons why investors are getting attracted to equity funds..
Why are mutual funds popular in India? The story of equity mutual funds in India can be explained by the heightened risk appetite of retail investors. Most investors are beginning to see the benefits of mutual funds in India as a distinct asset class. Let us look at 6 such drivers..

Bond returns have been consistently going down. Bank FD rates are just a tad above inflation and that is not exciting the retail investors too much. Retail investors are realizing that they need to participate in equities to generate wealth in the long run. Direct equities are too risky as they have experienced in the past. On the contrary, diversified equity funds have proved their capability to outperform the index consistently over the longer period.

Small savings were a preferred route for many retail investors; young and old alike. There are two factors working against these small savings. Firstly, the government has been cutting the rates on small savings as is already evident in the case of PPF and the RBI bonds. Additionally, the tax breaks that small savings they enjoyed could also reduce if the Income Tax Act shifts them to the EET model from the EEE model. Equity funds appear to be a better option.

Most retail investors are realizing the need to create a financial plan and once the plan is created they are realizing the futility of focusing on debt when they can afford to take the risk of equities. Small investors are realizing the actual corpus they will require in the long run and how equity mutual funds can help them build that corpus over a longer time frame.

Small investors are finally realizing the importance of discipline and the power of systematic investment plans (SIPs). That is evident from the sharp increase in SIPs. Investors are able to match their investments to their regular cash inflows and this has given them the dual benefit of rupee cost averaging as well as long-term wealth creation.

Equity funds are extremely tax efficient. Here is why! The dividends received on equity funds is totally tax free in the hands of the investor. Even the capital gains get preferential treatment in case of mutual funds. Short term gains (held for up to 1 year) are taxed at a concessional rate of 15% while long term gains (held for more than 1 year) are entirely tax free. If you investing in an ELSS, you get the additional benefit of exemption under Section 80C of the Income Tax Act. This tax-free status has been quite important in attracting investors to equity funds.

The introduction of direct plans by SEBI a few years ago has been instrumental in creating mass awareness of the benefits of investing in mutual funds. In the direct plans, investors do not have to pay entry loads and this reduces their cost ratios substantially. Over a longer period, their funds tend to outperform the indices more decisively.

The shift towards equity mutual funds investment appears to be obvious and with 6.65 crore folios, it finally appears to be attaining critical mass. Like in the US, the surge in retail investments is finally making equity mutual funds an important class in India!

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