Asset managers in India have universally welcomed a proposal by finance minister Pranab Mukherjee to open the country’s mutual funds industry to direct investment from foreigners.

Only foreign institutional investors (FIIs) registered with the Securities and Exchange Board of India (Sebi) and non-resident Indians are permitted to invest in mutual fund schemes at present.

But in his government budget speech on Monday, Mukherjee sprung a surprise by proposing to liberalise the portfolio investment scheme to permit Indian mutual funds to accept subscriptions directly from foreign investors who meet the know-your-customer requirements.

“This is the government’s recognition of the fact that this industry holds a pivotal role in the development of India’s financial markets and we hope that these are stepping stones towards further participation in managing long-term assets across the savings and investments spectrum,” says Ashu Suyash, managing director and India country head for Fidelity International.

All fund managers AsianInvestor spoke to are highly positive about this move, although they must await final guidelines from Sebi to comprehend the likely impact. Proposals are expected to be implemented within three months.

“Given the sensitive nature of the subject and the change or amendment in certain laws required before this can happen, it makes us take a wait-and-watch policy on how the same will eventually be implemented,” says Tushar Pradhan, CIO of HSBC Asset Management (India).

“While the domestic mutual fund industry will grow on its own steam in the coming years, this change could increase the source of assets available for domestic mutual funds to manage. However, access to global retail markets is not a given and the costs for raising assets globally may have to be considered. The ultimate cost-benefit of this situation is still unclear.”

What is clear is the government’s motivation: to increase foreign direct investment into the country. The Reserve Bank of India (RBI), the central bank, expects the nation’s current account deficit to be close to 3.5% of GDP for 2010/11 because of a rising oil import bill.

“While rising exports have helped in recent months, the government is looking at both foreign portfolio as well as FDI flows to bridge the gap,” says Vivek Kudva, managing director at Franklin Templeton Investments in India.

Anup Maheshwari, executive vice-president and head of equities and corporate strategy at DSP Blackrock Investment Managers, notes: “A lot of people have been investing in the country from the overseas route and their structures are short. The government probably wants more transparency in terms of investing into the market.”

India is striving to drive more single-country foreign investment over and above the pool of money that resides in emerging markets.

Hansi Mehrotra, head of Asia-Pacific wealth management for Mercer, notes that the allocation to emerging markets from pension funds still stands at just 5%, with institutional investors finding it difficult to access alpha from local managers for a long-term investment.

“So this legislation would help them go and buy a local name that supposedly knows the Indian market better over and above what they already have in emerging markets,” says Mehrotra.

She believes one impact could be that international asset managers will have to start proving what a good job they are doing in stock selection. She also wonders what will happen with fees. “My pension fund clients would not want to pay 2% for equities when they are used to 60bps.”

Most agree that the biggest winners will be investors as well as Indian AMCs with links to strong global distribution franchises that are licensed in jurisdictions around the world.

“It helps us a lot because we have a strong distribution network through Blackrock,” says  Maheshwar of DSP Blackrock Investment Managers.

He notes that domestic fund managers have a much longer track record of investing in the country’s stocks than offshore funds. “So it will be much easier to project these products to investors. The key is to have a good sales network.”

Sundeep Sikka, deputy CEO of Reliance Capital Asset Management, highlights the potential for garnering more equity mutual fund assets, which stands at $50 billion compared with foreign investment of $350 billion in Indian equities.

“Onshore asset managers have outperformed offshore managers over the long term,” he adds. “Moreover, there is a growing preference within the global investment community for investing through local managers with on-the-ground presence and capabilities. Clearly investors benefit the most from this change.”

Ajay Srinivasan, chief executive of financial services for the Aditya Birla Group, expects the move to have a limited impact on the industry in the short term as Indian AMCs concentrate on building distribution relationships offshore as well as their brands.

“Besides, there are several offshore funds already available to foreign investors, and one will have to think about how Indian funds will be able to compete with these funds,” he adds.

“Many players [with foreign distribution] in India have offshore funds dedicated to investing in India and will have to decide which set of funds to promote.”

But none of the sources expect this proposal to drive new product launches, given the large universe that already exists.

“India already has a big retail market,” says Suyash of Fidelity International. “This, however, will become an alternative route for foreign investors to invest in the Indian capital markets, especially in instances where they were looking to invest in products with a track record.”

Kudva of Franklin adds: “We don’t see the launch of new funds. However, based on specific interest we might see customised products being launched for foreign investors.”