IIFL And Its New Businesses

Q. The mutual fund industry has stagnated. How much of this can be blamed on the state of the markets and how much to regulations?
Nirmal Jain: In the Indian context, the mutual fund industry has not gathered as many assets as one would have expected. For a rapidly growing economy like India, equities can give good returns and for small investors, it makes a lot of sense to invest via mutual funds rather than directly approaching equities.

It’s a fairly complex problem. One cannot really blame the state of the markets or the regulators or even the industry participants. Given that our country is very large, a broad-based growth of the industry requires investment in investor education, infrastructure, and branches all over the country. It is vital that participants work together. There has to be a consensus that it is in public interest that we encourage and promote the mutual fund industry. Steps have to be taken to ensure that fiscal policies and regulatory environment is aimed towards the growth of the industry.

If the regulator’s mandate is only to regulate the market, then the approach will be different from a mandate to regulate as well as develop the market. For instance in the regulatory environment, if KYC, disclosure norms, reporting, etc. become tighter for millions of existing customers, it may well slow down the addition of new customers. In the Indian context, we have a very safe capital market which is more or less completely guarded from any large mishap or fraud. However, on the flip side we are very conducive for rapid growth or attracting small and new investors. Let me give you a crude analogy; road safety norms can be made so tight that no accident ever takes place. However, that will definitely have a major impact on the number of vehicles on the road and affect people’s willingness to own a vehicle or drive it.

Q. So even if the market is flat, the mutual fund industry would have done better if the regulator had not removed the entry load?
NJ: It is very difficult to imagine what could have happened if the regulator would not have removed the entry load. Unfortunately, for any decisions taken at the high level by regulators or the government, you cannot have the benefit of alternate history that – ‘what would have happened if not done this way’. There are pros and cons of both the approaches. When the entry load is removed, it should benefit customers because their returns increase by the amount of entry load. However, at the same time if there is no money left for distributors or mutual fund companies how would you expect them to reach out to customers, market the product or advise on the same. Also, if the customers themselves are not self-educated or take initiatives, the industry will not grow rapidly. In my opinion, regulators should not get into pricing but rather they should ensure that there is a fair competition which brings the pricing down. Earlier, the regulator did not permit any pass back out of the 2 percent entry load. This is also contradictory because in any product there can be MRP which the regulator can control. Beyond that they should allow players and distributors to compete amongst themselves. In hind sight, I feel it may have been a better approach to allow entry load and also allow distributors and manufacturers to have a lesser entry load or pass back part of it to the customers and compete. I think apprehensions that allowing pass back will make distributor or manufacturer push an inferior product is not valid, because if anybody knows for sure that this product is going to give lesser returns then that can be banned or relevant disclosures can be made. But the fact of the matter is that all we know is the historical performance which the regulator could have mandated to disclose to every investor who is making an investing decision.

Q. Now what is the way out for the MF industry?
NJ: I think the Mutual Fund industry may grow slowly and steadily but will grow for sure. In India, most of the players have entrepreneurial solutions. Now that the industry is getting reconciled to a new paradigm and a different structure, it will adjust and grow over a period of time.

Q. You are a brokerage house with strong belief in research. How come you went in for Exchange Traded Funds (ETFs) which are passive products?
NJ: The regulatory thought process and direction has been for low charge products and therefore we introduced an ETF with the lowest charge on the face of the Earth. Further, if we have an actively managed portfolio based on research, the cost goes up and our belief is that the small investors are better off broad-basing their portfolios on benchmark indices which have performed better than most of the funds in any case and importantly also bear the minimum cost. Large HNI investors who want to have actively managed portfolio can do it through PMS route as well. Over a period of time, we shall be introducing new products and that may cover equity mutual funds which are not passively managed.

Q. What is your view on algorithmic trading in India? Do you think that Indian brokers have the ability and the money to spend on technology like foreign brokers?
NJ: As technology progresses, algorithmic trading and technology driven trades are bound to grow. This will also need technology-savvy people employed by regulators to understand and mange the risk. It will be very difficult to ban or control these products but at the same time risk cannot be undermined. During the muhurat trade on Diwali, BSE had a huge systems failure where the risk management could not control the spate of algorithmic orders. The lesson here is to improve the risk management systems and control procedures and not to completely do away or ban algorithmic trading. I think the regulatory environment has become tighter, which is a positive step.

In terms of technology and cost, I do not think it is so significant that Indian brokers cannot afford it. Most of the Indian brokers are very well capitalised today and if the cost is justified by the business potential then they are in position to make the best of it.

IIFL’s equity broking income was down by 32.5 percent YOY, which is in line with the industry. In fact, if you consider the various aspects of performance of the overall market, we have done very well in the industry. However, being a large player we cannot ensure absolute growth but our volumes and business will broadly be in line with the market. It’s not a one-time problem which can be handled as the situation may recur because capital markets are cyclical in nature. We understand fully well that we are in a cyclical business so we plan our cost, revenue, expansion in the same manner and the downtown in fact is a good time to expand because cycles will definitely change.

Q. For the quarter ended December 31, 2011 you reported a fall in net profits by 46.6 percent. What is the reason for this?
NJ: A significant part of our costs are fixed and therefore any fall in volume will have more than a proportionate impact on the bottom line. On the upside, the same operating leverage will work positively.

Q. You are moving away from broking and into distribution.  Can you tell us more about your insurance distribution which is gaining business in spite of the industry showing lower growth?
NJ: It is not correct to say that we are moving away from broking, but if our distribution business grows faster, the relative share of broking may come down. We had started our insurance and mutual fund distribution business even before our broking business in the year 2000. And we have been the largest insurance distributor/broker amongst non-banking financial services companies. This business will also grow steadily and has tremendous long term potential.

Q. Rs 6,220 crore is a very small loan portfolio, How do you plan to grow in this business?
NJ: In a business of lending money one cannot grow many fold in a short span of time because there is always a risk of growth, faster than what you can manage. Rs 62.2 billion loan portfolio is a not really a small portfolio. However, this business will grow at a reasonable pace over the next three or four years.

Q. Real estate funds are a very competitive business. How do you plan to approach this space?
NJ: We have a very efficient team for managing the Real Estate Fund. Besides, in the last four to five years, we have funded a few real estate projects in which we got our customers to participate by way of subscribing to NCD and that has given them confidence in terms of the understanding of our real estate projects and the risks involved therein. The Fund Managers are incentivised on multiple criteria which include profits made by the fund.