Dipayan Ghose never knew too much about the stock markets; that there was money to be made in the nooks and crannies of Dalal Street. Then the benchmark index, the 30-share Sensex, hit 8,500, and Ghose suddenly realised that all those around him were rolling in the moolah. Determined not to be left out, he picked up one of those tip-sheets from his neighbourhood vendor, where he came across this gem of advice: "If you're a newcomer to equities, your best bet is to take the mutual fund route." That equity mutual funds have been clocking handsome double-digit returns, reinforced Ghose's belief that this was the most prudent way for him to pile up a hoard. He managed to lay his hands on an application form for a new fund offering of an equity scheme from a fund that boasted annualised 66 per cent returns as on September 30 on its other older stock offerings. Ghose filled up the form, opted for the growth option (who wants dividends, he shrugged), tore out a cheque for Rs 50,000 and put in his application at the authorised collection centre in the first week of October. By the end of the second week, the Sensex was in freefall, down some 500 points, and equity schemes were in the red by 3 per cent. Ghose was worried.

Ghose (not his real name), and thousands like him, would have had ample reason to be concerned last fortnight. For, as the indices continued to hurtle downwards -at the time of writing the Sensex had fallen to 8,201.73, a slump of 620.11 points from its peak-a good number of them who invested in equity schemes would have realised that their (plummeting) stash was locked in for three years. Only after that period could they ponder redemption. But if Ghose and his ilk are sporting furrowed foreheads, the Indian mutual fund industry isn't complaining at all. Reason? Assets managed by the Indian mutual fund industry grew 30 per cent in the first eight months of 2005, over the entire of 2004. Even better news: Assets of equity schemes managed by mutual funds jumped 67.5 per cent to Rs 55,743 crore in the same period. Inflows via equity new fund offers (NFOs) in the April-September period have already hit 16,500 crore (as against Rs 13,250 crore in the entire 2004-05 fiscal), and to top that, there are at least 16 more nfos in the pipeline (including four new tax-saver funds).

Investors are knocking the doors of mutual funds for investing in equity markets Pankaj Razdan CEO, Prudential ICICI AMC	Because of lack of depth in the market, Sachdev is focussing only on the top 100-200 stocks Sanjay Sachdev MD & CEO, Principal PNB AMC

Says Sanjay Sachdev, MD & CEO, Principal PNB AMC: "Lower assured returns due to falling interest rates and the lack of investing opportunities in other asset classes have resulted in investors getting attracted towards equity-and they are taking the mutual fund route." Adds A.K. Sridhar, Chief Investment Officer, UTI AMC: "New investors are tapping the equity markets through mutual funds." Sure enough, if investors are queuing up for application forms, it's also because they've been voyeuristically viewing the returns being dished out by the equity fund bunch. For the first eight months of 2005, equity schemes recorded a weighted average return of 24.4 per cent, in the process outperforming the returns of the Sensex and the bse-500 (which recorded an absolute return of 18 per cent each). The increasing thrust on equity-as of December, equity schemes accounted for 22.11 per cent of mutual fund-managed assets; by August that figure had shot up to 28.47 per cent-has also resulted in MFs accounting for 4 per cent of the turnover on the BSE and the NSE, as against 2.5 per cent six months ago.

The anxiety that prevailed last fortnight, however, revolved around whether the new flock of mf investors had got their timing all wrong. After all, if the stock markets slip into a deep correction, it will wash away a chunk of the gains of the newly-launched schemes. Points out Rajiv Shastri, CEO, Sahara Mutual Funds: "Investors who are rushing in to capitalise on the rising market and investing big money in NFOs (new fund offers) are carrying an immense risk in their portfolio."

That's the investor's headache. Shastri adds that the fund manager, too, comes under a lot of pressure at such times, and that's when "the discipline of investing in equity markets is lost". To be sure, most funds are sitting on an average of 10 per cent cash (see So Where Will the Cash Go?), with some like Deutsche Alpha Equity Fund and Birla Index fund cushioned by 46.24 per cent and 40.14 per cent, respectively. In a correcting market scenario, fund mangers typically use up these funds to buy stocks at lower prices, thereby lending support to the markets.

But if inflows from the foreign institutional investor (FII) brigade dry up-in the current month till October 13, the FIIs had sold Rs 964 crore of equities on the Indian markets-can we expect mutual funds to fill in the breach? The FII stash is bigger, but mutual funds aren't far behind: Foreign investors in the January-October period have poured Rs 36,500 crore on Dalal Street. Mutual funds meantime have mobilised Rs 24,000 crore through new equity offers in 2005, with nearly 60 per cent, or Rs 14,300 crore being fresh money (the rest can be accounted for by investors churning their portfolios and mark-to-market gains from equity schemes). Sahara's Shastri explains that even if 25 per cent of those fresh inflows are retail monies, it's a significant number. Ved Prakash Chaturvedi, Managing Director, Tata Mutual Fund, is more sanguine. He estimates that 80-85 per cent of the increase in mutual fund assets is courtesy of fresh flows. "Of this, retail inflows (including high-net worth clients) account for 65-70 per cent of the inflow in equity schemes," he adds.

The interest from retail investors is clearly visible in the increase in the number of applications for new NFOs. For instance, in June, Principal Junior Cap Fund received 75,000 applications and mobilised around Rs 440 crore. The latest NFO to close, SBIMF's Multicap Fund, received 3.75 lakh applications and mobilised Rs 2,100 crore. And Tata Mutual's Chaturvedi says he's expecting nearly 3.5 lakh applications for the Tata Contra Fund.

The lack of opportunities in other asset classes is prompting new investors to tap equity markets via mutual funds A.K. Sridhar CIO/UTI AMC	Fund managers are advising investors to have a three-four year horizon. Chaturvedi discourages investors even against one-year investment horizon Ved Prakash Chaturvedi MD/Tata Mutual Fund

That projection may just go a bit awry if investors tighten the purse strings, sensing (yet another) bull run going bust. The funds, for their part, might have an ideal product for such a situation: The Systematic Investment Plan (SIP) option, which not just reduces exposure to high-risk (by nature) equities, it also helps the investor garner more units when the market tanks. The sip operates like a recurring deposit of bank, with the investor parking upwards of Rs 500 per month with the fund, for which he gets in return his units. If he has Rs 5,000 to invest per month, he can divide that amount into five parts, and invest at five different dates, thereby allowing him to take advantage of market volatility.

Yet, sips on their own are inadequate protection for fund investors, many of whom tend to join the party at the peak of a rally. Realising the disastrous consequences these could have on their schemes-by way of large-scale redemptions-fund managers are advising investors to have a three-four year horizon. Says Principal's Sachdev: "We do not want money for the short term. Secondly with lack of depth in the market, we are focussing only on the top 100-200 stocks. The long-term trend is intact, but at current levels, stability in a stock is crucial and most of the funds are not comfortable with small stock." Tata's Chaturvedi says he's been discouraging investors with even a one-year investment horizon during the Tata Contra Fund roadshows.

Of course, there will always be investors looking to make quick profits, which results in them flitting from one fund to the other, resulting in a heavy churn factor, as high as 20-25 per cent. To deal with this, funds like SBIMF and Kotak AMC have introduced entry as well as exit load for their new and its existing funds. "We have introduced entry and exit load in our schemes mainly to cap our investors and to restrict churning," says Nitin Jain, Fund Manager at SBI AMC, who adds that excessive churning spoils the investment pattern in the fund. However, there are industry insiders who disapprove of such a move that makes short-term exits costlier. One such senior official at a state-run AMC accuses such funds of profiteering, as they receive a 2.25 per cent load on entry and a 1 per cent load on exit.

Such controversies notwithstanding, it would appear that the Indian mutual fund industry has hit an inflexion point-or at least the equity schemes have. As Pankaj Razdan, CEO, Prudential ICICI AMC, explains: "This time round, for the first time, investors are knocking the doors of the mutual fund for investing in the equity markets. And the inflows are also coming into existing schemes. Leaving aside the top five metros, 35 per cent incremental inflows into funds are coming from Tier-II cities." In the US in the nineties, huge money poured into mutual funds from us households, even as they became even bigger net sellers of stock (from sources other than mutual funds). If Indian mutual funds are able to ride out the current short-term blip, and dish out handsome returns to investors over the next 2-3 years, those rewards would go a long way in introducing many more domestic households to the mutual fund cult.