You are probably reading this article a few hours before the Finance Minister will present the new government’s first budget to the parliament. This is easily the most anticipated budget in many years, although I can’t quite figure out how much of the anticipation is justifiable and how much is mere hype.
All things considered, I fear that the hype has overtaken reality. Expectations, at least in the media, are now so high that the FM has little chance of actually being able to live up to them. It seems inevitable that many pundits will declare the budget a disappointment. Or perhaps I’m wrong and the congress’ post-electoral honeymoon is still going strong.
Either way, it’s being taken as a given that this budget is crucially important for investors, that the kind of person who reads this newspaper should probably listen carefully to every pronouncement and then rush to act upon it. In my view, nothing could be further than the truth. I don’t mean that the budget is not important, but that its real impact on your investments will be not of the sort that’s going to show up in an afternoon’s time. As it is every year, there will be a cycle of overreaction and corrections in which some predictions will turn out to be true and some false, probably on a random basis. If you look back on previous budgets, there’s never any sensible investing action that can be taken with any degree of confidence after listening to something in the speech.
However, this applies only to the direct and immediate impact on stock prices. The government’s actions on regulations and taxation are perfectly capable of changing the investing landscape in one stroke. This is precisely what is happening to mutual fund investing right now. Come August 1, new regulations issued by SEBI last week will completely transform equity fund investing in India. These changes will require a wrenching change in the business practices (and perhaps even business design) of fund distributors and fund companies. And while the changes will be beneficial for investors, the new rules will probably require them to become more knowledgeable about what they are doing.
As every mutual fund investor must know by now, SEBI has abolished entry load on mutual funds. Entry loads, generally around 2 to 3%, were deducted by fund companies from the investment in order to pay commission to the fund distributor.
This upfront commission was one of the two main payment streams from the fund to the distributor, the other being the so-called trail commission, which is paid at a rate of about 0.75% per annum. However, the upfront commission is effectively the biggest factor behind bad advice being given to equity fund investors. This commission structure means that it’s in the fund distributors’ interest to continuously make you sell your existing holdings and buy something else. This ‘churning’ was rampant in the fund industry.
Distributors of all sizes and scale from the soloist in your neighbourhood to the big banks’ wealth management units were guilty of this. All this is likely to stop now. SEBI’s new rules stipulate that the distributor will be paid directly by the investor whatever amount the two settle between them as a fair payment for services and advice rendered.
The new rules are based on the timetested principle of ‘He who pays the piper calls the tune.’ Earlier, the fund company paid the distributor and he was effectively their sales agent. Now, you pay him and he should hopefully be your advisor. Of course, he now has two paymasters because he gets the trail commission from the fund company. However, these commissions also have to be revealed to the customer under the new rules.
I expect the fund distribution market will soon get sorted out on the basis of service level and investment size. Investors will effectively pay less if they have larger investments or can get by with lower service levels. Online investing, which is inherently lower cost, should also become more attractive. In any case, the new rules will drive investors towards more awareness and distributors towards more openness. And that can’t be a bad thing.
All things considered, I fear that the hype has overtaken reality. Expectations, at least in the media, are now so high that the FM has little chance of actually being able to live up to them. It seems inevitable that many pundits will declare the budget a disappointment. Or perhaps I’m wrong and the congress’ post-electoral honeymoon is still going strong.
Either way, it’s being taken as a given that this budget is crucially important for investors, that the kind of person who reads this newspaper should probably listen carefully to every pronouncement and then rush to act upon it. In my view, nothing could be further than the truth. I don’t mean that the budget is not important, but that its real impact on your investments will be not of the sort that’s going to show up in an afternoon’s time. As it is every year, there will be a cycle of overreaction and corrections in which some predictions will turn out to be true and some false, probably on a random basis. If you look back on previous budgets, there’s never any sensible investing action that can be taken with any degree of confidence after listening to something in the speech.
However, this applies only to the direct and immediate impact on stock prices. The government’s actions on regulations and taxation are perfectly capable of changing the investing landscape in one stroke. This is precisely what is happening to mutual fund investing right now. Come August 1, new regulations issued by SEBI last week will completely transform equity fund investing in India. These changes will require a wrenching change in the business practices (and perhaps even business design) of fund distributors and fund companies. And while the changes will be beneficial for investors, the new rules will probably require them to become more knowledgeable about what they are doing.
As every mutual fund investor must know by now, SEBI has abolished entry load on mutual funds. Entry loads, generally around 2 to 3%, were deducted by fund companies from the investment in order to pay commission to the fund distributor.
This upfront commission was one of the two main payment streams from the fund to the distributor, the other being the so-called trail commission, which is paid at a rate of about 0.75% per annum. However, the upfront commission is effectively the biggest factor behind bad advice being given to equity fund investors. This commission structure means that it’s in the fund distributors’ interest to continuously make you sell your existing holdings and buy something else. This ‘churning’ was rampant in the fund industry.
Distributors of all sizes and scale from the soloist in your neighbourhood to the big banks’ wealth management units were guilty of this. All this is likely to stop now. SEBI’s new rules stipulate that the distributor will be paid directly by the investor whatever amount the two settle between them as a fair payment for services and advice rendered.
The new rules are based on the timetested principle of ‘He who pays the piper calls the tune.’ Earlier, the fund company paid the distributor and he was effectively their sales agent. Now, you pay him and he should hopefully be your advisor. Of course, he now has two paymasters because he gets the trail commission from the fund company. However, these commissions also have to be revealed to the customer under the new rules.
I expect the fund distribution market will soon get sorted out on the basis of service level and investment size. Investors will effectively pay less if they have larger investments or can get by with lower service levels. Online investing, which is inherently lower cost, should also become more attractive. In any case, the new rules will drive investors towards more awareness and distributors towards more openness. And that can’t be a bad thing.
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