Sunday, August 23, 2009

No More Entry Loads for Mutual Funds: What does it mean for you?

Changing Regulations
The recent ruling by the Securities and Exchange Board of India, SEBI, on the removal of entry load on mutual fund (MF) investments has brought appreciation as well as criticism from different corners. Last year SEBI had already done away with entry loads in cases where the investors directly invested in mutual funds without going through an agent or a distributor.
Changing regulations is not a new trend in the mutual fund industry; we have had previous rulings which seemed difficult and cumbersome to implement at the time but have been adopted by all affected parties over time. In 2001, SEBI made AMFI (Association of Mutual Funds in India) certification compulsory to sell Mutual Funds which was accepted after initial protest from distributors. Similarly, a PAN (Permanent Account Number) was made compulsory for all Mutual Fund investments in 2007 and KYC (Know Your Customer) compliance was made mandatory last year. In spite of all the objections, over time everyone has accepted the changes, adapted to them and moved on.
What does it mean financially?
With the new ruling in place, investors will be free to negotiate the commission with their distributor. Good news for some, not so good news for others. Let us have a look as to who stands to benefit ,who stands to lose and the implications of SEBI's decision for investors and financial advisors.
The below mentioned table gives an indication of the effect of the no entry load ruling on your investments:
Why do investors need help with investing decisions?
The above table is based on the assumption that there will be no loads on MFs which would be the case only if one decides to invest directly through a fund house and not through an advisor.
However, it may not be advisable for investors to go direct as:
- There are vast numbers of products/mutual fund companies/asset classes available in the market to choose from. Making the choice merits advice from a qualified professional to avoid making mistakes and be sure to be invested with products compatible with one’s goals, timeframe and risk appetite.
- Many do not have the time, expertise or inclination to research and identify the appropriate investment avenues based on his/her requirements.
- When investing on your own, it becomes difficult to take the emotion out of your investment decisions. A financial advisor would take investment decisions which would be research driven and will not involve emotion. With thousands of schemes, volatile markets (necessitating buy/sell/hold decisions) and servicing issues, investors will need the help of an advisor.
Benefits to the Industry and Investors
This new rule should be welcomed by investors and financial advisors as it reiterates the view that the Investor-Advisor relationship should be increasingly focused on the services the advisor provides through better execution, better research, and customization . It calls for bringing transparency and knowledge output into the system. Needless to say, instances of investors being misled into a transaction would decrease considerably as a result of the SEBI decision if investor education is also implemented. On the part of distributors, the decision underlines the importance to disseminate quality advice, which is in sync with the life goals of an individual. Here, financial planning gets merit over other similar services. This is a paradigm shift in the services rendered , from transaction-driven to process-oriented, and from product-centric to client-centric.
The proposed format of services is practiced by financial planners worldwide. The immediate demand on distributors is to improve their skills by understanding the impact of different mutual fund product categories based on risk, return and taxation. Recommendations need to be made from the viewpoint of an investor's goals and must be carefully analysed. The asset allocation prior to and post investing in a product should be in line with the financial goals of a client. The investment product should match the cash flow needs of a client.
These are accepted criteria, among others, that a Certified Financial Planner, certified by FPSB India, employs while recommending a product to clients. Thus, the SEBI decision calls for a complete overhaul in the way financial advisory will be delivered in future.
Charging fees directly from the client might have been looked as an obscure concept, however SEBI has dispelled all myths. The SEBI directive would also initiate other global certifications in the discipline to be established. A suitable code of ethics as well as practice guidelines should drive the relationship between investors and advisors.
Summary of Benefits
To summarize, the benefits of this ruling to investors are:
  • Distributors will get a fee for their advice and hence distributors will be forced to give the right advice rather than promoting schemes, which offer them superior brokerage commissions (is it true that taking a fee will make them give right advice, is there any way to guarantee this?)
  • No more churning of investors’ portfolios which many distributors used to indulge in, especially when a New Fund Offer (NFO) would be announced to earn hefty commissions without any care for your money. (However, there is a possibility of increase in churning to earn by way of the exit loads when selling is done. We’ll need to keep an eye on this)
  • The relationship between the advisor and investor becomes more process-driven and customer-centric rather than transaction-based. Increase in demand for professional advice would increase competition in the advisory business and improve the quality of investment advice offered, thereby benefiting investors.
  • Certification will become increasingly important in the advisory business which would mean more regulations to protect consumers & standardization of advice across the board.

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