Could Zerodha disrupt the mutual fund distribution business?
India’s largest brokerage Zerodha announced on Wednesday that it had received in-principle approval from the markets regulator to launch a mutual fund (MF). It will become India’s 46th fund house, entering a crowded but growing sector.
Why are so many firms entering the industry?
A Securities and Exchange Board of India (Sebi) board meeting decision in December 2020 eased the rules for entities to sponsor MFs to “facilitate innovation and enhanced reach to more investors at a faster pace including tech-enabled solutions". Sebi laid down that applicants who do not fulfil the profitability criteria can get MF licences if they have a net worth of ₹100 crore. This net worth threshold has to be maintained by the sponsor till it makes profit for at least five consecutive years. For fintechs offering direct plans of MFs which bring no commissions, a fund house can provide a path to monetization.
What impact will Zerodha’s entry have?
Costs have been dropping in India’s MF industry following Sebi’s caps on expense ratios in December 2018. The growing assets under management of low cost passive funds, the growth of direct MF platform and the assets held in commission-free direct plans have strengthened this trend. Investors are thus likely to benefit from the lower fees and increased competition in the industry. In stock broking, Zerodha brought down brokerage costs across the board, with a number of established players subsequently lowering their brokerage as well. The firm may replicate its ‘discount broking’ model in the MF space.
Why is passive investing favoured by new entrants?
According to media reports, Zerodha will focus on low-cost passive funds. Such funds simply track indices rather than attempt to beat them and this allows them to keep costs low. Actively managed funds have failed to beat indices in growing numbers and this is turning investors towards passive funds. Launching passive funds is also cheaper for fund houses.
Can there be conflicts of interest?
Zerodha also allows investors to buy direct plans of MFs through its platform ‘Coin’. However, when Zerodha launches an MF, there may be an incentive for the firm to direct Coin users towards its own fund house. This can also be an issue for customers of other MF distributors or fintech platforms which have applied for MF licences or acquired fund houses such as Groww and the NJ Group. It can work as backward integration for them, but they will have to maintain boundaries between distribution and fund management arms.
Can Zerodha manage money?
Zerodha does not manage money. Zerodha co-founder Nikhil Kamath has managed the proprietary money of the founders in the past. He also set up an Alternative Investment Funds provider called True Beacon in 2019. However, according to a senior executive, it will be kept completely separate from the AMC business. Zerodha will broadly focus on passive funds that don’t need active management. For these types of funds, investors should evaluate the type of index selected and the tracking error (deviation from index returns) the fund has.
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