Officials from Vanguard, one of the largest fund houses in the US, and a pioneer of index investing, made a trip to India and went back unconvinced of the “India opportunity”

Foreign manufacturing and service companies see a great opportunity in India as the economy races towards a 9% growth for 2011, but one sector where foreign companies are currently less enthusiastic about is the fund management business.

While several Indian asset management companies (AMCs) are keen on selling out or selling a strategic stake as a prelude to eventual exit, large foreign AMCs are not keen to bite right away. Two weeks ago, a team from US fund giant Vanguard, which specialises in offering index funds of all flavours, visited India to see if the time was right for them for setting up shop here and after several rounds of talks left unimpressed by the scope of the opportunity.

Vanguard's interest is relevant in the context of stepped-up offering of index funds by Indian mutual funds. Over the past decade, there have been only about 20 index funds. But suddenly in the last few months, four new index funds have hit the market. The entrants are Taurus Index Fund, IDFC Nifty Fund and IDBI Nifty Index Fund-and ICICI Pru is launching Nifty Junior Index Fund.

Vanguard, founded by John Bogle, is the world's pioneer in index investing. Its classic index product charges just 0.25% as opposed to 1.5% charge of Indian index funds. For many years, very few fund houses in India have offered index funds assuming that active fund management in a variety of flavours would be the right product for investors. But index funds have often beaten actively-managed funds under different market conditions and so there is not much greater interest in indexing. Attracted by the Indian opportunity, a Vanguard team visited India recently. "But having reviewed the situation, they have concluded that while the market is interesting, they would rather wait and watch," says the CEO of an AMC whom the Vanguard team had met.

The experiences of foreign mutual funds in India and Indian investors who have invested in them have been rather spotty. While the foreign fund companies have not made much money for themselves, their fund management prowess has not benefited Indian investors either. Several of the global majors came to India in the early years of liberalisation to manage the rising domestic savings. Morgan Stanley, one of the largest US fund houses, was not only the first off the block but it was also the among the first private mutual fund companies in India following the new fund regulations announced by the regulator in 1993. Templeton, another large fund house, launched its first fund in August 1996 with its Growth Fund. Thereafter Merrill Lynch (now BlackRock), Pioneer, T Rowe Price and Primarica-among many others-have entered the Indian market.

The public's experience with the two first global giants was distressful. When Morgan Stanley launched its Growth Fund, a close-ended fund, in January 1994, investors braved freezing temperatures and rain at many places to put in Rs1,000 crore into the fund. In fact, like the rush to buy hot primary issues, an investor frenzy developed, leading to an illegal futures market of Morgan's yet-to-be-issued units. However, many of the companies were small with bloated balance sheets, inflated promise of earnings, of small market capitalisation, illiquid shares and run by dubious promoters. By 2003, after almost a decade of investing, the fund delivered just about 3% return. The returns became a bit respectable in the massive bull run of 2003-2005.

Templeton India launched its Growth Fund in August 1996 but it had made an annualised return of just around 6%-far lower than the average bank deposit rate over this period. This growth fund avoided growth stocks in pharmaceuticals, software and consumer sectors and bought stocks of poorly-governed companies that earned a low return on capital, at very high prices. Its performance has remained average in subsequent years, barely beating the averages.

Foreign fund companies have been taking a long-term view hoping that rising savings of the more prosperous middle class will flow into mutual funds but very few have invested for the long term. Most fund companies took the easy route to launch frequent new funds in a bull market (which led to poor returns) and also tap the corporate treasuries for debt and liquid funds, taking advantage of lower taxes for such funds. This has led to average returns and poor penetration. Recently, regulatory changes have tried to introduce better practices but it is not clear if fund companies are up to it.