This paper studies the behavior of open ended equity funds and medium- and long-term debt funds in India under regulatory cost and management fee ceiling constraints. It attempts to see if competition renders regulation unimportant. Smaller equity funds spend lesser on marketing and waive a portion of their management fee to keep expenses below the ceiling. This tendency disappears as we reach the highest asset class which also appears to face diseconomies of scale. When controlled for regulatory cost ceilings, there are no economies of scale present. Debt funds are not constrained by regulatory cost ceilings as much as by the need for them to deliver better returns with decreasing debt returns and high equity returns. Their expenses and management fee are much below regulatory ceilings throughout all asset classes and tend to reflect true economies.

Indian mutual funds have come a long way since the `liberalization' in 1993 when the private sector was allowed to participate. Prior to 1993, only public sector financial institutions were allowed to float funds. Since 1993, the size of the mutual fund industry has increased from Rs. 47 bn to Rs. 2327.4 bn with almost 21 million investors as on march 2006. The number of fund complexes has also risen from 10 to 29 during 1993-2006, with a total of 449 funds, with 55 new funds added in 2005-06. The types of funds have also been getting increasingly diverse trying to cater to the risk profile of potential clients.

With the growing size of funds, economies of scale in administration expenses is possible. The benefits of lower average costs would be passed on to shareholders in an industry that is competitive. This would lower expense ratios. For fund complexes with a large number of funds, economies of scope can provide further avenues for reduction of expenses. Since fund managers derive their profits from management fees, they would certainly strive to increase the asset size under their management. For this they have to compete with other funds for investor's pool of savings. It is possible that funds might also decrease their management fees voluntarily to attract more funds. Theoretically, this is viable up to the point where the marginal benefit of fee reduction (in terms of asset increase) is equal to the marginal cost (reduction in total fees). Reduction in fees would, however depend on investor preferences between price and non-price factors in choosing funds to invest in. Non-price competition through product diversification, advertisements and after sales services can help to reduce elasticity of demand with respect to fees. But given that most services are mandatory, price competition may still be important.

Applied Finance Journal, True Economies, Forced Economies, Indian Funds, Securities and Exchange Board of India , SEBI, Literature Review, Mutual Fund Industry, Equity Mutual Funds, Mutual Fund Administration, Equity Fund Management, Standard Deviation, Indian Stock Markets, SEBI Regulations.