With investment flows shrinking, mounting competition and operating costs being stubborn and high, India’s fund management industry is facing a major slump.

Mesmerized by a five-year bull run in which stocks rose by 500%, investors poured into equity funds. The ‘bullish’ fervor lead to the industry growing more than 4-fold over the period to manage Rs. 5.5 trillion by the end of 2007. Assets have shrunk by 55 since then. Such situation has lead the smaller firms to thinking of investment in mutual funds as a mistake.

Equity fund inflows fell to their lowest in June, since August 2006, and new stock funds have collected just Rs. 18.3 billion so far in fiscal 2009, compared to Rs. 63.35 billion in the year-earlier period. It is estimated that the profitability of the industry could drop to below 15 basepoints this year, as compared to 23 basepoints last year. Hence, if people have spent a lot of money in building their business, and they are looking for a payback this year, they are not going to get it.

India’s fund industry has also found operating margins squeezed by spiraling real estate and staff costs. India is an emerging market with first world prices whereby it is characterized by expensive office locations. Also, salary costs remain high wherein firms compete to hire and retain the fast growing industry’s limited talent pool.

Analysts believe the bearish sentiments in the market and hardening of interest rates have lead to heavy redemptions, leading to sharp drop in assets under management (AUMs). The fund houses must be prepared for the prospect that profits could be off some time.