Mutual Funds: still relevant, or losing their edge?

Mutual funds have been a consistent stalwart in the Indian retail investment space for years now, from monthly SIPs dripping in on the 5th day of each month to lump sums being invested before the ELSS cut-off date. Today, however, the situation is far more complex. The inflows continue to be strong – but the environment has never been more crowded. Is the Indian mutual fund industry at a crossroads, or is it just heading towards an inflexion point?

The bull case: numbers don't lie

It's difficult to dispute these numbers. The AUM of India's mutual fund industry grew at an unprecedented rate over the last decade, breaking through the ₹65 lakh crore mark in 2026. Monthly investments in SIPs regularly surpass ₹26,000 crore – something that would've seemed surreal even five years ago. This isn't about retail participation anymore; it's about the new reality.

SEBI's emphasis on investor education, direct plans with zero commission, and the availability of convenient trading apps such as Zerodha, Groww, and Paytm Money have made this possible. The first-time investors from Tier 2 and Tier 3 cities are making it happen, bringing about a revolution that would've been inconceivable before COVID.

The scope of these mutual funds is now also broader than ever before. From mutual funds tracking the performance of the Nifty 50 index to thematic funds based on AI infrastructure or green energy, there's a mutual fund for every investment hypothesis that retail investors can come up with.

The bear case: a crowded room

But even here, as the tale unfolds into one of triumph, storm clouds begin to gather. And there isn't just one threat to mutual funds. Today, the competition comes from a group of other players, each taking a bite out of the pie.

• Direct Equities & Smallcases: Portfolio of stocks provides clarity and an element of ‘ownership feel’ which cannot be matched by mutual funds. (Clarity Advantage)

• REITs & InvITs: Income-generating plays through assets attract investors who have turned their back on debt funds since taxation. (Income Advantage)
• PMS & AIFs: Investors with higher net worth have moved to portfolio management at premium levels. (Premium Level)
• Cryptocurrencies & Digital Assets: An increasingly popular segment with higher risk for young investors. (High Risk)

This 2023 regulatory move, eliminating the indexation benefit in terms of long-term capital gains on debt investments, can be considered one of the worst impacts on any category to date. The effect on capital flow was significant and resulted in substantial capital allocation to insurance-based saving schemes and direct bonds. However, fund houses have attempted to counteract this with new concepts such as target maturity schemes.

On another note, passively managed funds are a threat from within. With the increasing credibility of low-cost index funds and ETFs, investors find it increasingly difficult to justify the costs incurred by the hiring of active fund managers, especially when the statistics show that most large-cap active funds do not beat the index over five to ten years.

Strengths & vulnerabilities at a glance

Strengths:

• Regulatory oversight & investor protection
• Instant diversification at low ticket sizes
• SIP discipline builds long-term habits
• Wide category choice (equity, debt, hybrid)
• Tax efficiency via ELSS & indexation (equity)
• Professional management for passive investors

Vulnerabilities:

• Debt fund taxation changed the calculus
• Most active funds lag benchmarks long-term
• PMS/AIF pulling HNI capital upmarket
• Smallcases is gaining traction for DIY investors
• Crypto attracting younger risk appetite
• Fee pressure from passive alternatives

The passive revolution inside the industry

Perhaps most ignored is the story of the mutual fund industry eating into its own profits by actively managed investments. While the assets under index funds have doubled in the last three years, assets under active funds have only increased by just over 50%. The companies making a name for themselves through stock selection, like HDFC Mutual Fund or Mirae, are now the biggest sellers of passively managed funds.

This does not mean that the game has been compromised; rather, it has meant adapting to the demands of the market. It is clear that the industry has come to terms with the need to make itself more accessible to customers, and that even if it costs more in terms of money, it is worth it.

What investors should actually think about

The discussion on mutual fund relevance, in some cases, may be misplaced. There are different types of funds out there. While a well-run flexi-cap fund may not have many similarities with a liquid fund or an ELSS plan, what one really needs to determine is whether the particular fund category is still the right approach to meet specific objectives.

An investor who is a salary earner and has 15 years to reach his financial goals is better served by a Nifty 50 index fund with a systematic investment plan. On the other hand, an investor looking to earn regular returns from his fixed assets may find a debt fund’s after-tax returns underperforming to that of a bond portfolio. Healthy competition should be welcomed. It will help lower expenses, improve products and increase transparency.

Conclusion

But mutual funds are not becoming irrelevant; they are becoming less exclusive. They have been the only game in town for individual investors for decades, but their time is up, and it is to be applauded. Individual savings can benefit immensely from healthy competition and diversity, rather than being subject to a monopoly. Mutual funds that will succeed in the coming years will do so because they offer something superior through and through: low costs, legitimate alpha, and appropriate categorisation.