The Role of Mutual Funds in an Economy
Over the past few decades, the role of mutual funds as a dependable source of investment in a world of uncertain finances. has grown significantly. The power granted to the purchaser of investing in a dozen different securities without burning a hole through the pocket as well as the reduced dependency on a specific source of income makes for a very lucrative investment option. All the benefit without the anxiety! This unique advantage of mutual funds over other investment choices gives them a place of particular importance in the economy.
However, many of us have only a hazy idea of what mutual funds are, the way they work, and the role of mutual funds in the economy. Let’s smooth those tangles out.
What are Mutual Funds?
Investopedia defines mutual funds as, ‘an investment vehicle made up of a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments, and other assets’. That’s quite a mouthful! To break it down into simple English, a mutual fund is a repository of money where you and many other people together invest in multiple securities instead of investing in a single company.
For instance, say Mark and Matt both have 10,000 bucks.
Mark invests the entire amount in the stocks of a particular company. The shares of the company rise the next day and Mark’s amount increases by about 30%. Mark is happy. However, the very next day, the stocks collapse to 50% of the original price making Mark’s share half of what it was worth. Mark is financially ruined.
On the other hand, Matt approaches a mutual funds advisor who gives him five different options of high-, moderate-, and low-risk companies. Sensible Matt invests 2,000 bucks in each of these companies. Now, even if the stocks of one of the companies fall or soars, then Matt is going to be financially stable.
When a hundred such Matts come together, you get a mutual fund – a steady pool of mutual money that is used to invest wisely in bonds, shares, and assets.
Mutual funds are a smart way of diversifying your funds across a varied portfolio. You can invest in different sectors and industries in a cost-effective manner. The different types of mutual funds, such as equity funds, balanced funds, index funds, etc. give you the power to diversify your portfolio based on your investment style.
Mutual Funds as Financial Intermediaries
As the term suggests, a ‘financial intermediary’ is any entity that acts as a middleman in financial transactions, between the relevant parties. This can be anything, a bank, mutual funds, pensions funds, investment companies, etc. The principal advantage of a financial intermediary is that it is able to circulate funds as necessary, distributing the available funds based on the financial need of the company. Consequently, the market remains stable and reduces the chances of financial extremes.
Mutual funds successfully fulfil this exact role and are hence called financial intermediaries. The funds collected from investors are handled actively by mutual fund managers, who purchase assets for stockholders as per their discretion. The companies that are invested in, benefit from the capital received and hence improve their performance, which prompts investors to entrust capital again. This is a cyclic process providing mutual benefit to shareholders and companies, which maintains financial stability and market liquidity.
Thus, the role of mutual funds is active as well as important as financial intermediaries.
The Role of Mutual Funds in Shaping Indian Economy
Mutual funds have a long and successful history in India. It all started with the formation of the Unit Trust of India in 1963, created by the Government of India and the Reserve Bank of India. In the next two decades, various players from the public and private sectors entered the mutual fund market, which was now thriving. The SEBI Regulations in 1996 and the exemption of mutual funds from income tax dividends since 1999 were two fundamental turning points in making mutual funds more palatable to the public.
In the last 15 years, mutual funds have shifted towards a phase of consolidation and cohesive growth. Mergers of renowned private sector fund houses and increasing awareness amongst investors contributing to the growth of the mutual funds market in India.
Throughout this period, the role of mutual funds has been significant in shaping the Indian economy and keep it stable due to the diversification of investment capital. There have been varying trends in the mutual funds market, which have influenced the shareholders’ investment decisions. For instance, in the early 90s, UTI was the most popular option for investing in mutual funds, given its history and stability. In the 2000s, income/debt-based schemes became very popular, as the average Indian preferred a low-risk investment due to a conservative outlook. The age, occupation, place of residence, and gender of the investor have also influenced shareholder decisions to a large extent.
The steady growth in mutual funds investment is reflected in the consistent development of the Indian economy, barring a few instances. From a bird’s eye perspective, there are four critical aspects of the financial system – stability, efficiency, transparency, and inclusion. As an intermediary that improves each of these aspects, mutual funds are a definite contributor towards the financial development of the country.
As a pool of resources, the large volume of mutual funds allows for active participation in the financial market, improving inclusion and efficiency of the market. The diversification of mutual funds is an informed decision based on extensive market research, in-depth market analysis, and a deep understanding of the financial currents. There is no guesswork or bidding on dark horses. Every decision is data-driven and this knowledge of risks and returns creates a stable market. Complete transparency about investment strategies and expected returns gives investors a clear idea of the ground they stand on, which creates trust and economic certainty among shareholders.
All these factors contribute towards the total economic stability of the country making them a chef influencer of the Indian economy.
Mutual funds have helped bolster the economy on many an occasion. Post the introduction of the Money Market Mutual Funds (MMMF) in 1991, there has been a steady rise in short-term investments. The number of investors grew by 22 lakhs in 2014-15. The investor mindset has changed over the years and people are willing to invest in moderate-risk assets. The typical shareholder is now aware of the current economic scenario and tends to conduct his own research as well, in addition to taking advice from mutual fund managers.
However, the current awareness about the advantages of investing in mutual funds is limited to the middle- and high-income households, concentrated in cities. The rural market remains as yet, comparatively untapped. There is a great opportunity here for fund managers, which can be mutually beneficial for investors and companies alike. The mutual fund industry needs to take into account the rural scenario and work towards creating awareness and substantiating economic growth in that sector as well.
Looking towards the future, there is a great need for a focused and driven approach towards mutual funds investment, to shape our economy better. Innovative schemes that have a better return on investment and lower risks can be devised to attract investors. The Indian economy has developed into a strong entity, in part due to the mutual fund industry. Nevertheless, the road ahead is a difficult one. Mutual funds investments have the potential to become an integral part of our economy, provided fund houses, mutual fund managers, and investors themselves work in three-part harmony towards creating a stable and efficient market.