ETFs and Mutual Fund Industry Rebalancing in India: Capital Reallocation and Regulatory Shifts

India's ETF and mutual fund industry is undergoing a seismic transformation in 2025, driven by regulatory reforms, investor behavior shifts, and structural adaptations by asset management companies (AMCs). As the market size surges-domestic mutual fund assets grew 34% in FY2024, according to a BankersAdda report-the focus is shifting from mere growth to a more nuanced rebalancing of capital flows, cost structures, and competitive dynamics. This article unpacks how SEBI's 2025 fee reforms, digitalization, and institutional innovations are reshaping the landscape.

Regulatory Reforms: A New Fee Framework

The Securities and Exchange Board of India (SEBI) has introduced sweeping changes to mutual fund fee structures, targeting cost efficiency and transparency. Key reforms include:
- A 15 basis point reduction in the Total Expense Ratio (TER) for open-ended equity funds, as reported in a BankersAdda report.
- Exclusion of statutory levies like GST, STT, and stamp duty from the TER cap, as noted in the BankersAdda report.
- Brokerage costs slashed to 2 basis points for cash trades and 1 basis point for derivatives, as detailed in an ETNow report.

These changes aim to align AMCs' earnings with investor returns, a first-of-its-kind move in India. For example, performance-linked fees now allow AMCs to charge higher fees for outperforming funds, incentivizing better returns, according to a Business Standard article. According to Akhil Chaturvedi of Motilal Oswal AMC, these reforms are expected to benefit investors by reducing operating and trade costs without significantly impacting AMCs, as reported in an Economic Times piece.

Capital Reallocation Dynamics: Where Is the Money Flowing?

The reforms are already reshaping capital flows. Systematic Investment Plan (SIP) inflows have consistently exceeded ₹280 billion monthly, as noted in a Financial Express article, with total mutual fund Assets Under Management (AUM) crossing ₹65,000 billion, according to the same Financial Express article. Investors are increasingly favoring direct mutual fund investments due to lower expense ratios and transparency, as described in the Financial Express article.

Small-cap funds exemplify this shift: their AUM grew 83% year-on-year to ₹2.43 lakh crore by March 2024, according to the BankersAdda report. This surge reflects retail investors' appetite for high-growth opportunities, facilitated by improved digital infrastructure and fintech partnerships, as noted in the BankersAdda report. Meanwhile, the average SIP size is projected to rise from ₹3,000 to ₹5,000 in 3–4 years as financial literacy improves, according to a Nasdaq article.

Structural Shifts in AMCs: Adaptation and Innovation

AMCs are recalibrating their strategies to survive the new fee environment. SBI's upcoming IPO for its mutual fund arm, SBI Funds Management, is a case in point. By selling a 6.3% stake, SBI aims to boost market participation and awareness of mutual funds, as reported in a MarketScreener report. This move mirrors broader industry trends: AMCs are leveraging digital platforms, performance-linked fee models, and institutional partnerships to retain competitiveness.

SEBI's anchor investor reforms further illustrate structural adaptation. The reservation for anchor investors in IPOs has increased to 40%, with 33% reserved for mutual funds, as noted in a Financial Express article. This change is expected to deepen institutional participation and stabilize capital flows during market volatility, as noted in the Financial Express article.

Investor Behavior: Cost-Conscious and Digitally Savvy

Retail investors are becoming more discerning. The preference for direct investing-bypassing intermediaries to access lower-cost funds-has surged, as described in the Financial Express article. Additionally, the average retail investor now compares funds using simplified fee disclosures, a direct result of SEBI's transparency mandates, as noted in the BankersAdda report.

Digitalization has been a game-changer. With 181.5 million mutual fund accounts as of April 2024, according to the BankersAdda report, smaller towns and cities are now key growth engines. Fintech platforms and mobile apps have democratized access, enabling even first-time investors to navigate complex products like small-cap funds, as noted in the BankersAdda report.

The Road Ahead: Challenges and Opportunities

While the reforms are largely positive, challenges remain. AMCs must balance cost reductions with maintaining service quality, and investors need to avoid overconcentration in high-risk small-cap funds. However, the long-term outlook is optimistic: favorable government policies, rising liquidity, and a maturing investor base position India's ETF and mutual fund industry for sustained growth, according to the BankersAdda report.