With commissions likely to head down, independent distributors will have to diversify revenue streams by selling other financial products such as insurance, postal schemes and fixed deposits to offset the revenue losses.
The suspense over the issue of entry loads on mutual funds was finally resolved last week with the Securities and Exchange Board of India (SEBI) conveying its decision to scrap entry load for mutual fund schemes. The distributors, the backbone of the industry, are disappointed by the decision of the regulator with some even considering boycotting sale of mutual fund products as a mark of protest.
What distributors perceive
Under the new scheme, distributors and investors have to agree mutually to a fee structure for the service to be provided. Distributors fear that once investors know the service rendered, they may bargain hard and try to pitch one distributor against another to get a better deal.
It is also possible that investors, after taking advice from the distributor may proceed to invest directly in the funds recommended, to save the commission. Yet, distributors should also understand that in a free, competitive market, the quality of service offered by them is the best insurance against this eventuality.
With commissions likely to head down, the distributor will need to increase the volume of business drastically, to make up. Larger distributors may cut down costs by closing down offices, reducing marketing expenses and variable commissions paid to employees.
Independent distributors may have to look out for more diversified revenue streams by selling other financial products such as insurance, postal schemes and fixed deposits to offset the revenue losses. Independent financial advisors in tier 2 and tier 3 towns fear that they will find it very difficult to convince investors for a fee. Advisors in tier 3 cities have to travel 20-30 km at times, to procure business and the ticket size of such a business will not be remunerative if the fee is negotiated.
This will lead to a situation where the distributors may not provide service to small investors.
Unlike the insurance industry, mutual funds have neither the branch connectivity nor employee strength to entertain investors directly. Even if the investor goes directly to the fund house, one will not be sure of unbiased recommendation on the products based on the investor’s risk appetite.
Incidentally, last year SEBI has abolished entry load for direct applications yet only 10 per cent of fund investors since then have actually chosen to go directly to the funds. Distributors point to this saying that investors need the support of advisors to decide on the investment.
Under the new scheme, distributors and investors have to agree mutually to a fee structure for the service to be provided. Distributors fear that once investors know the service rendered, they may bargain hard and try to pitch one distributor against another to get a better deal.
It is also possible that investors, after taking advice from the distributor may proceed to invest directly in the funds recommended, to save the commission. Yet, distributors should also understand that in a free, competitive market, the quality of service offered by them is the best insurance against this eventuality.
With commissions likely to head down, the distributor will need to increase the volume of business drastically, to make up. Larger distributors may cut down costs by closing down offices, reducing marketing expenses and variable commissions paid to employees.
Independent distributors may have to look out for more diversified revenue streams by selling other financial products such as insurance, postal schemes and fixed deposits to offset the revenue losses. Independent financial advisors in tier 2 and tier 3 towns fear that they will find it very difficult to convince investors for a fee. Advisors in tier 3 cities have to travel 20-30 km at times, to procure business and the ticket size of such a business will not be remunerative if the fee is negotiated.
This will lead to a situation where the distributors may not provide service to small investors.
Unlike the insurance industry, mutual funds have neither the branch connectivity nor employee strength to entertain investors directly. Even if the investor goes directly to the fund house, one will not be sure of unbiased recommendation on the products based on the investor’s risk appetite.
Incidentally, last year SEBI has abolished entry load for direct applications yet only 10 per cent of fund investors since then have actually chosen to go directly to the funds. Distributors point to this saying that investors need the support of advisors to decide on the investment.
Existing system
In the current system, AMCs charge 2.25 per cent as entry load to investors. Smaller funds charge an entry load of 2.25 per cent for an investment value up to Rs 2 crore while the bigger ones charge load up to Rs 5 crore. Out of the 2.25 per cent entry load, AMCs usually part with a 2 percentage point commission to distributors, retaining the rest for other expenses.
Apart from the entry load commission, distributors also receive trail fee, an annual fee that is much smaller, pegged to the asset size they bring in. If the distributor is able to market Rs 2 crore worth of funds, he may earn commission of Rs 4 lakh less service tax of 10.3 per cent.
For an investment of Rs 25,000 he may earn commission of Rs 500 less service tax. In addition to this, is the trail feesof 0.40-0.50 per cent per annum. Managing the business on trail fees alone will not be viable unless the distributor manages a fairly large asset portfolio.
One option that funds have is to increase the trail fees to encourage distributors in the new milieu. This has to come from the recurring expense (2.5 per cent for load-based schemes currently) that funds charge, while computing the NAV. The recurring expenses now include investment management advisory fee charged by the AMC, registrar and transfer agents’ fee, marketing and selling costs, and so on.
There is a possibility that AMCs will approach SEBI to enhance this recurring charge; allowing them to pay distributors an extra trail fee to encourage them to bring in fresh business and try to expand the penetration in tier 2 and tier 3 cities.
Funds may well be forced to do this because their profitability is slipping already and they cannot bear the additional expense of a higher trail fee. According to the recent report published by KPMG, though the AUM of mutual funds has grown by CAGR of 35 per cent in the past five years, the profitability of the AMCs has slipped from 24 bps in FY04 to 14 bps in FY08.
Penetration level of mutual fund products is low in smaller towns and cities with the top 10 cities accounting for close to 80 per cent of assets under management. With the abolition of the incentive of entry loads that rewards distributors, achieving better spread may well turn out to be a tall order.
In the current system, AMCs charge 2.25 per cent as entry load to investors. Smaller funds charge an entry load of 2.25 per cent for an investment value up to Rs 2 crore while the bigger ones charge load up to Rs 5 crore. Out of the 2.25 per cent entry load, AMCs usually part with a 2 percentage point commission to distributors, retaining the rest for other expenses.
Apart from the entry load commission, distributors also receive trail fee, an annual fee that is much smaller, pegged to the asset size they bring in. If the distributor is able to market Rs 2 crore worth of funds, he may earn commission of Rs 4 lakh less service tax of 10.3 per cent.
For an investment of Rs 25,000 he may earn commission of Rs 500 less service tax. In addition to this, is the trail feesof 0.40-0.50 per cent per annum. Managing the business on trail fees alone will not be viable unless the distributor manages a fairly large asset portfolio.
One option that funds have is to increase the trail fees to encourage distributors in the new milieu. This has to come from the recurring expense (2.5 per cent for load-based schemes currently) that funds charge, while computing the NAV. The recurring expenses now include investment management advisory fee charged by the AMC, registrar and transfer agents’ fee, marketing and selling costs, and so on.
There is a possibility that AMCs will approach SEBI to enhance this recurring charge; allowing them to pay distributors an extra trail fee to encourage them to bring in fresh business and try to expand the penetration in tier 2 and tier 3 cities.
Funds may well be forced to do this because their profitability is slipping already and they cannot bear the additional expense of a higher trail fee. According to the recent report published by KPMG, though the AUM of mutual funds has grown by CAGR of 35 per cent in the past five years, the profitability of the AMCs has slipped from 24 bps in FY04 to 14 bps in FY08.
Penetration level of mutual fund products is low in smaller towns and cities with the top 10 cities accounting for close to 80 per cent of assets under management. With the abolition of the incentive of entry loads that rewards distributors, achieving better spread may well turn out to be a tall order.
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