No Entry Load for Mutual Funds : The Good, The Bad, The Ugly
In a significant decision, SEBI has removed the entry load on the investors for current or new mutual fund schemes.
“There shall be no entry load for the schemes, existing or new, of a Mutual Fund. The upfront commission to distributors shall be paid by the investor to the distributor directly. The distributors shall disclose the commission, trail or otherwise, received by them for different schemes/ mutual funds which they are distributing or advising the investors.” SEBI Press Release 192/2009.
Today after almost 12 years of open-ended era, Mutual fund AUM has reached close to Rs. 6.5 bn with approx 8mn folios, which is still approx 20% of the overall bank deposits and not even 1% of the population to MF folios. Most of this is through the Debt schemes which by and large are not affected by this move. It is the retail equity culture (or the lack of it) that is worst affected by this.
Investors are the clear intended beneficiaries of this move; complete transparency, no mis-selling, no more price-influenced advice, and definitely no greed based churning of the portfolios. Now mutual fund products, arguably the cheapest option for investors, just got cheaper!
But this begs the question that if MF products are already quite cheap as compared to say insurance products, is there a need to further reduce costs? Will this not stifle the marketing attempt to spread out the MF products across the breadth of the country? Where are the commercials for the AMCs or Distributors to sell the product in say Tier 2 or Tier 3 cities let alone smaller towns? Let’s face it. Investment products have to be marketed and sold. If an investment oriented insurance product has as much as 10% variability in cost structure a similar investment oriented MF product earlier had a 2.5%
band width, which now stands revised close to zero. Eventually the small and medium retail investors will drift to the insurance products and end up paying higher! Are they then the real beneficiaries?
Or has the financial regulation in this country has decided that an investor segmentation is the need of the hour. Insurance (or investment products coming out of insurance companies) is for Retail and the open ended investment products of AMC’s are for the affluent.
The regulation also says that the investor will now pay the distributor. Imagine a situation; A retail customer walks into a distribution unit with an equity investment application for Rs.10,000/-. In the current scenario, he expects some thing back as commission. Now, can he be explained that he is going to get a better NAV and therefore he should pay Rs 50 or 100 as advisory fee? Well. This is what is being expected by saying “The upfront commission to distributors shall be paid by the investor to the distributor directly”. One is not sure how practical this measure is and whether this works even for market savvy, whole sale participants. The investor however smart would not like to pay for a distribution or for an AMC marketing service.
This will therefore trigger a re-positioning of the business plans of AMCs and distribution networks. AMCs need to plan their distribution network to reach out to retail customers or concentrate only on high end businesses. For AMCs, the rich will become richer and the small will face more difficulties to grow business
The distribution businesses built on Channel model are the most effected with these new norms. Since the arrangement going forth is, the fee is to be provided directly to the advisor by the customer, the scope of intermediaries will be a question mark. The mass retail business will be commercially unviable for distribution houses to sell mutual funds. The mass retail MF business will tilt towards online side and the geographical penetration in rural/ new locations will certainly come to a halt. Since, customer will decide the fee for the advisors; the institutional mutual fund advisory business will be
more competitive and will also open for the organised players who earlier were not participating in it due to unfair means for the pass backs. Affluent/ high end business will become competitive on the basis of service & advice. The advisors have to invest much more on the technology & serious research so as to create a visible value to the investor
Some businesses worked for years to create a stable annuity from mutual funds assets, by selling a very prudent and investor friendly product “SIP” (systematic investment plans), based on the principles on average rupee cost. They have accordingly invested initially and worked on the NPV benefits of the business. With the new norms on no entry load on existing & new schemes, the question arises on the assumptions on which these businesses had been built with a focus on discounting the future revenues. One good thing that may emerge from these norms is that it would hit those of the distribution community whose revenue dependence was largely on the portfolio churn of the customers.
The new “Mantra” for the business planning in AMC’s may be CDSE (Cumulative Deferred Sales Expenses), which is going to be very important decision by AMC’s to put in various schemes to pay off various distribution channels upfront commission in lieu of entry loads. Instead of taking any further cost to their profit & loss accounts, AMC’s can introduce CDSE in the schemes to meet the need of distributors to get up-fronts for survival and to look MF as a product to sell to their (??) customers. But eventually this measure will too affect the P&L of AMC’s either by margins or by creating working capital provisions to fund the upfront brokerages. The “trade-off” is going to be crucial in the strategies of various AMC’s and raise issues on the basic capital norms for the AMC’s. Eventually the current minimum capital norms for AMC business (Rs.100mn capital) will have to be revised upwards in recognition of the hard reality that long term custom cannot be created from a stable investor base without decent marketing and sales budgets
In the end
In conclusion, the effects of the new regulation are mixed. Part of it is very good, especially the push to abolish churn based selling and the pressure on AMC’s to take a re look at the Capital. The bad part is the impracticality of investor paying for distribution service. The ugly one easily is the segmentation that is indirectly being thrust on the investor community based on size; i.e., if you are small, go for insurance products (even if they are investment products) and if you are rich enough to be approached by an AMC or a Distributor, you can take a look at MF products