Zerodha's Entry into Mutual Funds: Challenges and Prospects in the Indian Market
The Indian mutual fund market is witnessing a new entrant, Zerodha, as it aims to leverage its existing client base to venture into this substantial financial arena. With a market already dominated by established players, this development raises the question of its potential impact. This article explores the challenges and prospects of Zerodha's foray into mutual funds, with a focus on the critical role of performance in attracting and retaining investors.
The Current Scenario in Mutual Funds
As of July 31, 2022, there are 43 Mutual Fund (MF) houses in India managing assets worth Rs. 37,76,911.15 crore. The entry of Zerodha into mutual funds is unlikely to make a significant difference. Historically, one additional MF house has not significantly altered the market dynamics. Additionally, Zerodha's primary customer base consists of momentum traders attracted by its cost-effective brokerage model. These investors are usually not interested in the long-term investment strategy required for MFs, where consistent performance is crucial to maintain investor retention.
In contrast to Zerodha's trading business, where revenue is generated irrespective of investor performance, mutual funds require superior investment outcomes to retain clients. Poor performance can lead to outflows of capital and loss of customers. When a well-known mutual fund like HDFC lags in performance, it becomes evident that a strong, consistent track record is essential. This highlights the significant challenge Zerodha faces in carving out a niche in the competitive mutual fund market.
Zerodha's Entry into Mutual Funds
On September 1, 2021, Zerodha, one of India's largest discount brokers, obtained in-principle approval from the Securities and Exchange Board of India (SEBI) to launch a mutual fund business. Start-up mutual fund houses like Zerodha will face intense competition in India's over Rs 35 trillion mutual fund market, where just ten of the 43 existing MF houses manage more than a trillion rupees. Among them, seven are bank-sponsored, providing extensive branch distribution networks. A prime example of this is the SBI Balanced Advantage Fund NFO, which raised Rs 14,500 crore.
Given these challenges, one strategy Zerodha can adopt is to offer low-cost passive funds, minimizing fund management risk by replicating market benchmarks. For instance, the Navi Nifty50 index fund, introduced in July, has an expense ratio of just 0.06%. Lower expense ratios are critical, as demonstrated by the savings in performance. Assuming an investment in Scheme A with a 0.10% expense ratio and Scheme B with a 1.2% expense ratio, an initial investment of Rs 1 lakh over ten years with a 14% equity market growth would yield Rs 3.67 lakh for Scheme A and Rs 3.33 lakh for Scheme B. That represents an approximate Rs 34,000 in savings due to modest expense ratios.
Challenges of Large-Cap Funds
The Indian mutual fund market has seen a significant shift in the performance of large-cap funds. Regulatory reforms in recent years have made it challenging for large-cap mutual funds to outperform their benchmark indices. A Moneycontrol investigation found that only 20% of large-cap funds outperformed their benchmarks over a three-year period as of 2016. This trend suggests that Zerodha will need to closely monitor its performance to maintain investor interest.
Role of Fintech Distributors
Fintech distributors have been rapidly gaining traction, drawing a considerable number of new investors who prefer online transactions. According to industry estimates, nine of the top 21 distributors in terms of new systematic investment plan (SIP) accounts launched in July 2021 were fintech distributors. By leveraging fintech, Zerodha can attract new customers more effectively, capitalizing on the growing preference for digital banking and investment solutions.
Experts believe that new-age, digital-focused fund houses like Zerodha will not only acquire more new customers over time but also drive competition among other fund houses to enhance their digital capabilities. This will create opportunities for diverse talent to join the industry, further enriching its skill set.
In conclusion, while Zerodha's entry into mutual funds presents challenges, its ability to offer low-cost, passive funds and leverage fintech to attract and retain investors remains promising. However, consistent performance will be the key to its success in this competitive market.