Nearly every statistic about flows into public equities from domestic investors from mutual funds is grim. Equity schemes have seen consistent outflows regardless of the fund house since mid-2009. With indices near all-time highs, sentiment resoundingly bullish, and FIIs singing the India growth story, this is a tough pill to swallow.
Stretched valuations are clearly not the story, because private equity has seen a very different experience. Domestically, institutional investors such as banks have traditionally favored private equity investments over public equity ones because of restrictions on investments in public equity. HNI and retail money on the other hand, was a more level playing field.
Of late, however, HNI participation in mutual funds has tapered off while sales of private equity funds, particularly those launched by domestic players, have picked up substantially.
On average, private equity funds launched for the HNI have had more success over the last year than mutual fund NFOs. It’s also hard to believe this difference is because private equity offers a much better value proposition. If anything, mutual funds are one of the most well regulated and transparent investment platforms available in India. The difference is attributable largely to economics.
HNI fund sales in India are distributor driven for both public and private equity funds.While globally private equity is an asset class for ultra high net worth individuals, in India, private equity funds are sold to individuals starting at ten lakhs, which skims the borderline of HNI.
This class of HNIs is often unclear what exactly a private equity fund is and how it differs from their standard investments, and relies on the distributor to educate them. As a result, private equity managers like public managers have to depend on distributors for a bulk of their sales, and shape their value proposition accordingly.
Typically private equity funds are structured as closed ended funds with three to five year lock-ins, and can offer the first year or two of management fees as upfront commissions to the distributor. Mutual funds are largely open-ended, and can offer much more limited upfront payments, because there is no certainty about the duration of the investment. Why? Some would argue that investors are ready to buy a closed ended private equity fund because of the unique value proposition, but are hesitant to lock in money into a public equity fund.
In fact, the one class of mutual funds that is closed-ended, the three year locked-in equity linked savings scheme (ELSS) does pay higher upfront commissions, and continues to see robust sales. Moreover, with the ban on entry loads on mutual funds last year, mutual funds have lost a critical sales card, that private funds still have in hand.
The result? Private equity gets the distributors’ mindshare and the investors’ money, sometimes in cases where the investor, a small HNI, might have been better off with a simple mutual fund.
Private equity does have its space in a portfolio particularly for large HNIs, but the allocation should be driven by investor risk profile not commission economics. This onus is on the investor who needs to understand products on offer, ask intelligent questions, and “buy” products instead of being “sold” them.
(Radhika Gupta is a Founder Director with Forefront Capital Management, a SEBI registered portfolio manager, and India’s first specialized quant manager. She was also a strategy consultant with McKinsey and Company (New York). Radhika graduated from the Wharton School at the University of Pennsylvania.)