Mutual funds are widely recognized as a versatile investment option that pools money from multiple investors to invest in various asset classes, such as listed equities, debentures and other money market instruments. They serve as the best investment avenue, particularly for investors with limited financial knowledge, enabling them to participate in the capital market. In recent years, the mutual fund industry of Nepal has experienced explosive growth, expanding from just two schemes in 2013 schemes to a staggering 43 schemes (including both closed and open-ended funds) as of 2025. This remarkable growth has been driven by several factors, including increasing participation in the stock market (evidenced by the rise in demat account holders), limited alternative investment opportunities, growing financial literacy, and the success stories of the country’s first two mutual funds.

The funds are managed by finance professionals, known as fund managers, who possess strong expertise and a deep understanding of investment portfolio management. Acting on behalf of unit holders, they analyze market trends and adapt to changing dynamics, making informed investments decisions to optimize returns. The returns generated by the funds are distributed proportionately among unit holders after deducting applicable expenses set by the regulator. This distribution is based on the net asset value (NAV) of the fund.

Current Industry size

The mutual fund industry has been on a steady growth trajectory since the introduction of the Mutual Fund Regulation Act 2010 which laid the foundation for its development. Today, the industry boasts 43 operational schemes with a total fund size of approximately Rs 50 billion. Out of these 43 schemes, 36 are closed-end schemes. Additionally, several new schemes are in the pipeline for New Funds Offerings (NFOs). The industry’s journey began in 2012 with the launch of the first mutual fund within an initial fund size of Rs 50 million by Siddhartha Capital. Since then, the industry has grown significantly, achieving a compound annual growth rate (CAGR) of 36%. Over the past decade, the total fund size has surged from Rs 1.25 billion to Rs 50 billion. This growth can largely be attributed to the success story of the first two funds, which delivered returns exceeding a 20% CAGR. Additionally, limited investment avenues for market participants and ease accessibility of higher returns for institutional investors through mutual fund schemes have further driven investor interest. These developments have lowered barriers to entry, enabling greater participation by retail investors in the secondary market.

Despite this progress, the mutual fund industry remains in its nascent stages compared to global standards. The ratio of asset under management (AUM) to the country’s GDP stands at just 0.88%. For context, India’s mutual fund AUM represents 13% to 15.8% of its GDP, while the US mutual fund industry accounts for 140% of its GDP, according to the World Bank’s 2021 report. However, the sector holds significant potential for expansion and plays a crucial role in stabilizing the secondary market of Nepal.

In comparison, India’s mutual fund Industry has experienced remarkable growth, offering a diverse range of schemes to cater to its growing population. Since the launch of its first mutual fund in 1963, India’s AUM has soared to approximately Rs 108.8 trillion as of November 2024, reflecting a CAGR of 21.13% since 2014. Similarly, Bangladesh started its journey with the launch of the closed-end “First ICB” fund by the Investment Corporation of Bangladesh in April 1980. As of 2022, the country has 58 registered asset management companies (AMCs) managing 36 closed-end and 88 open-end mutual funds. The AUM of closed-end funds stood at approximately 61.96 billion Bangladeshi Taka (BDT), while open-end funds accounted for 56.07 billion BDT, according to the 2023 report by EBL Securities Bangladesh. However, despite a CAGR of 7.72% in AUM from 2017 to 2022, the sector’s share of GDP declined from 0.31% to 0.24% during the same period.

Correlation of Mutual Fund Index and NEPSE Index

The graph below clearly illustrates that mutual fund performance is often closely correlated with the overall market index (i.e. NEPSE Index). It is because mutual fund schemes typically allocate a significant portion of their assets to equity shares of listed companies. As a result, a bullish NEPSE index generally leads to an increase in Net Asset Value (NAV) of mutual funds, along with the potential for higher dividends and market prices for unit holders. Furthermore, many mutual funds adopt portfolio strategies that closely mirror the NEPSE index. This approach allows them to align the risk and return profiles with the broader market, enabling them to capitalize on market trends while providing investors with diversified exposure to overall market performance.

The Role of the Mutual Funds Industry

The mutual funds industry has become a vital investment vehicle for global investors, and Nepal is gradually joining this growing trend. Mutual funds pool money from individual investors and allocate it across various asset classes, ranging from equities to short-term liquid assets. Their primary objectives include incremental value creation, wealth generation, financial stability and providing regular income through dividends. At their core, mutual funds aim to deliver consistent returns to unit holders while adhering to their specific investment goals.

Managed by a professional fund management institution—a relatively new concept in Nepal—mutual funds enable individual investors to gain access to professionally-managed portfolios. This allows investors to benefit from economies of scale and diversify their risk across a wide range of investments. Additionally, mutual funds play a stabilizing role in the market by injecting liquidity into the secondary market, particularly during periods of low trading volume. By enhancing market liquidity, these funds contribute to economic growth, as businesses gain access to larger funding sources through the pooled resources of mutual fund schemes.

Analysis of Mutual Fund Performance

Matured Mutual Funds

In Nepal, mutual funds have been an alternative investment option for over a decade since the launch of the first mutual fund, SIGS1, in 2012. Over the years, some matured mutual funds have already completed their tenure and redeemed their funds, while others remain active. The graph below illustrates the compounded annual return (CAGR) of various matured mutual funds, comparing their performance with NEPSE return and fixed deposit returns over the same period. Out of 12 matured mutual funds, nearly all have performed well, significantly outperforming the average returns of fixed deposits except for three funds that underperformed. These three are considered new and unconventional investments in the context of Nepali investors’ norms. However, 11 out of the 12 matured mutual funds convincingly outperformed the NEPSE index, further solidifying mutual funds’ position as one of the best alternative financial assets in the capital market.

SIGS1 and NBF1 were able to generate very high annual compounded returns compared to other 11 funds. This exceptional performance can be attributed to their timely entry into the market and their ability to adjust their portfolios effectively to capitalize on growth opportunities. Both funds were launched at the onset of the 2013 bull rally, positioning them perfectly to take full advantage of the bullish momentum. Additionally, their fund sizes—Rs 500 million and Rs 750 million, respectively—were substantial relative to market turnover which was around Rs 1 billion at the peak of 2015/16. Apart from those two funds, others with relatively lower CAGR still managed to outperform the NEPSE, except for NIBSF1.

A key factor contributing to the success of SIGS1 and NBF1 was the mandatory SEBON’s (Securities Board of Nepal) mandatory 5% IPO allocation policy which provided these funds with lucrative opportunities to generate great returns. With only a few mutual funds operating at that time, the additional IPO quota allowed fund managers to maximize returns. Furthermore, the hydropower and microfinance sectors dominated Nepal’s Initial Public Offerings (IPO) from FY 2013 to FY 2023, with an average of Rs 3.50 billion worth of IPOs issued annually. This steady stream of IPOs provided mutual funds with fresh investment opportunities, enhancing their performance and attracting more investors. The attractive returns delivered by matured mutual funds have set a promising precedent, encouraging the growth of new mutual funds schemes and increasing investor participation. This success has reinforced the idea that professionally managed, well-structured funds can offer safer and more rewarding returns compared to randomly selected stocks without proper financial research.

Current Mutual Fund Scenario

While the historical performance of matured mutual funds paints a promising picture for Nepal mutual fund industry, this study aims to evaluate whether such exceptional performance persists in the current market scenario. Focusing on mutual funds launched in FY2019, the study uses Net Asset Value (NAV) reports published as of January 26, 2025. The findings reveal that the average CAGR return of these funds is 11.66%, with SFMF and NMB50 leading the sector by generating returns of 15.52% and 15.76%, respectively. While these returns are superior compared to the sector average, they are relatively lower compared to the average CAGR of 12.05% achieved by matured mutual funds. One major reason for this under performance could be the timing of their issuance.

Most of these funds entered the market during a bearish phase that began after the peak of FY 2016/17, exposing them to unfavorable market conditions from the outset. Additionally, rising average fixed deposit rates has posed a challenge. The average fixed deposit rate for three-year terms from early 2019 to the end of 2023 stood at 9.54%, according to the Nepal Rastra Bank (NRB) data. Despite these challenges, a few funds, such as SEF and CMF1, have managed to generate returns on par with or slightly above the average fixed deposit return of 8.65%. Notably, NMB50 and SFMF have delivered returns exceeding 15%, positioning them among top-performing funds. However, even these two funds’ returns are slightly below the NEPSE CAGR.

The remaining funds have struggled to strongly outperform the NEPSE Index, likely due to the prolonged bearish market following the peak of FY 2020/21, exacerbated by high average fixed deposit rates of 9.87% from July 2021 to January 2024. This period saw dwindling liquidity, rising interest rates and slowing economic growth, all of which contributed to a downturn in the NEPSE index. These factors made it challenging for fund managers and investors to compete against high interest rates.

Mutual Fund Performance in the Bull rally of FY 2020/21

The mutual fund industry is still in its early growth stages. Given that various funds commenced operations at different times, analyzing their performance collectively would not provide a fair or justified assessment. The recent bull rally, which occurred between mid-2020 and mid-2021, significantly reshaped the narrative of Nepal’s capital market. A surge in market participation, the rise of online trading and ample margin facilities fueled unprecedented growth, pushing the NEPSE index to an all-time time high of 3200 in 2021. This surge has fundamentally transformed the investment landscape in Nepal.

All existing mutual funds performed exceptionally during their period. However, only two funds—NIBLPF and SAEF—stood out with superior performance, coming close to matching the NEPSE Index. No other funds were able to generate returns exceeding the NEPSE index which delivered an 80.87% return during the rally. The returns of these existing mutual funds ranged from 33.66% to 70.43%, falling short of the NEPSE index. This underperformance is often tied to overall market fluctuations. This could be the reason for the mutual fund schemes being unable to generate excess returns.

Unlike India, where mutual funds can invest in a wide range of securities as per SEBI guidelines—such as real estate investment trusts (REITs), gilt funds, derivative instruments, gold ETFs, and other assets—to hedge risks and enhance returns, Nepal’s mutual funds face restricted investment avenues. Despite these limitations, fund managers have managed to deliver stable returns which is commendable. However, their inability to fully capitalize on favorable market conditions represents a significant lost opportunity.

Conclusion

Nepal’s mutual fund industry is still in its nascent stages. While the capital market is growing and a few experienced fund managers have delivered decent performance, the industry faces unique challenges. The primary challenge for fund managers is generating excess returns through solid research, strategic securities selection, informed decision-making and effective asset allocation aligned with market behavior. A key debate in portfolio management revolves around the ideal number of stocks a mutual fund should hold to achieve returns of 13% to 15% while minimizing unsystematic risk remains ongoing. According to published NAV reports, most mutual funds hold an average of 60 to 70 stocks. However, modern portfolio theory (MPT) does not focus on a specific number of stocks but emphasizes diversification across uncorrelated asset classes to reduce risk efficiently. Research suggests that holding between 20 and 30 stocks can optimize returns while minimizing risk, achieve a higher Sharpe ratio and lower standard deviation. Over diversification beyond this range can dilute returns, increased management expenses and fail to meaningfully reduce risk. Many mutual fund portfolios in Nepal resemble index funds, closely mirroring overall market performance. Mutual funds should consider reducing the number of stocks in their portfolios, allowing fund managers to focus on thorough research and sharp investment strategies aimed at generating returns that surpass the market average.

Additionally, the current structure of closed-end mutual funds, with relatively short durations of five or seven years, exposes them to market cycles and volatility. Extending the duration of these funds to 10-12 years would allow them to ride out market cycles and generate higher compounding returns. Encouraging retail participation through regulatory reforms—such as tax rebates for unit holders and the introduction of new financial instruments—could further drive the growth of the mutual fund industry. These changes would not only strengthen the industry’s prospects but also build trust among retail participants, reinforcing the belief that long-term wealth creation is achievable through professional fund management institutions.

(Luitel has worked in capital markets as Portfolio Manager and Research Analyst.)

(This opinion article was originally published in   April 2025   issue of New Business Age Magazine.)