Monday, June 22, 2009

Sebi move may boost ULIPs over mutual funds

Investors may be thanking market regulator Sebi for doing away with entry load on mutual fund (MF) investment, but industry players believe the move may adversely affect them, as they fear distributors would push unit linked insurance plans (ULIPs) to earn better commission.
ULIPs offer attractive front-end commissions to agents. However, independent financial advisors believe that though there is a possibility of some distributors favouring ULIPs in the short-term, the new directive would be beneficial for both the industry and investors in the long run.
"This clearly puts the insurance industry in an advantageous position. Why would a distributor sell MF schemes where he earns nothing, when he can sell a ULIP product and get a very high commission," asks an industry player.
In fact, this was the pet theme at a CII-organised MF summit recently, where the Association of MFs in India (AMFI) chairman raised the issue in the presence of Sebi chief C B Bhave. However, the Sebi chief made it clear that the industry should try to convey to the investors that lower commission MF scheme would help them earn more. With no entry load, investors stand to gain more, as the impact of it on long term investments would be huge because of the effect of compounding rate returns, Bhave said.
Independent financial advisors say the MF industry's fears are exaggerated. "If at all there is an adverse impact, it will be only in the short-term. Distributors will not survive selling only ULIP products. It is the business model of banks where they want to earn more front-end commissions by selling insurance products," says Gaurav Mashruwala, a certified financial planner.
Agrees Devendra Nevgi, another financial expert. "It is well known that ULIPs have much higher commission rates than MFs. Some people have been pushing them aggressively already," he says. Both believe the new Sebi directive would improve the quality of distributors in the country.

Entry of global mutual fund cos hit due to low profitability

Rising cost pressure and fall in profitability in the Indian mutual fund industry has hit the entry plans of global players in the country, a CII-KPMG report said.
"Rising cost pressures and decline in profitability have impacted the entry plans of global players eyeing an Indian presence," the report said.
The recently released report pointed out the profitability in the Indian mutual fund industry has not been commensurate with the Assets Under Management (AUM) growth over the last five years.
The report after analysing the financial statements of Asset Management Companies (AMC) pointed out while the AUM grew at 35 per cent in the period from 2005 to 2009, the profitability of AMCs (which is defined as profit before tax as a percentage of the AUM), declined from 0.24 per cent in 2004 to 0.14 per cent in 2008.
The report said another reason that may affect the entry of foreign players is the rising cost structure here.
It said the operating expense as a percentage of AUM rose from 0.41 per cent in 2004 to 1.13 per cent in 2008 due to increased spend on marketing, distribution and administrative expenses which impacted AMCs' margins.

Time to fix insurance — for good

An innocuous, almost obvious piece of regulation that should have been introduced in 1994 when mutual funds were opened up to private asset management companies (AMC) finally saw the light of day last week. It may have taken a decade-and-a-half in coming, but to me, it’s a huge relief to see a regulator serve its first function: to protect the interests of investors.
“There shall be no entry load for the schemes, existing or new, of a mutual fund,” a June 18 decision of Securities and Exchange Board of India (SEBI) board meeting stated. “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.”
There’s pandemonium among AMCs — companies that are authorised by SEBI to float mutual funds. The reason is not that distributors who sell the funds to investors will not get the 2.25 per cent commission on every equity fund purchase we make. Compared to the 40 per cent commissions on investment products masquerading as insurance, mutual funds were doomed to begin with in this arena.
The reason is that with no incentive to sell low-cost, high-disclosure and transparently cost-structured mutual funds under an able and investor-friendly SEBI chairman C.B. Bhave, the only investment instrument distributors will now sell will be high-cost, opaque and terribly mis-sold insurance products.
Meanwhile, the leadership of the insurance regulator, the Insurance Regulatory and Development Authority (IRDA) seems to be “serial investor unfriendly.” J. Hari Narayan is the third chairman of IRDA who has done -- and is doing -- nothing to stem the rot that the industry and its distributors have been inflicting on consumers for years. All through, IRDA has, like a bystander, allowed this first product of finance to be mis-sold, through its pious focus on ‘penetration’ and not the first clause of its mission: to protect the interests of policyholders.
The fight in Indian financial services seen from the consumer’s point of view is one of skewed commission structures. When an agent sells an insurance investment he pockets Rs 40,000 for every Rs 1 lakh invested. The same investment gets him Rs 2,250 when he sells an equity mutual fund (it’s lower for debt funds). And when he sells a pension fund, he gets Rs 100. Put yourself in the agent’s shoes and ask yourself this question: which product will you sell?
The answer is clear to consumers in urban areas as well as rural ones. When I was studying farming in four villages of Uttarakhand last month to see what the problem with agriculture is, I noticed that apart from biscuits, tea and mobile connections, the one financial product that many of the “poor” people owned that was like their urban cousins was a high-cost insurance policy-- an investment product in the garb of life insurance.
“While the elaborate sales and distribution model has contributed to the popularity of life insurance, this has come at considerable cost by way of high commissions and a large per cent of lapsed policies,” notes ‘A Hundred Small Steps: Report of the Committee on Financial Sector Reforms,’ a Planning Commission report chaired by Raghuram G. Rajan.
“Policy lapses are low only in the highest income quartile, while in all other segments at least 20 per cent respondents have had a policy lapse. The penetration of non-life insurance products is negligible. For example, only 1 per cent of the population appears to have medical insurance,” it says.
The problem, therefore, is not with the distributor, who will naturally seek higher returns, or with insurance companies, who look for sales.
The problem only partially lies with inept regulators --- tucked away in Hyderabad, with little exposure or interest in the nuances finance or consumer interest, and rendered largely toothless.
To me, the problem is that the political economy of the NDA regime could not prevent Chandrababu Naidu, who acting in the best interest of his state thought he was earning the people’s mandate by getting IRDA to be housed in Hyderabad. This action needs to be reversed. Today, Prime Minister Manmohan Singh has a political mandate that gives him a chance to fix the mess in India’s regulatory space, much in tune with the rest of the world. There are lessons to be learnt from US President Barack Obama’s straight speaking and regulatory overhaul this month.
Here are three ways I think Singh can fix this problem for good.
One, set up an agency like Obama’s Consumer Financial Protection Agency with a mandate to protect consumers of credit, savings, payment, and other consumer financial products and services, and to regulate providers of such products and services, across regulators.
Two, initiate a new legislation for financial intermediaries and bring all distributors, agents, advisors under its single ambit.
And three, move IRDA to Mumbai, the financial centre.

Source:http://www.hindustantimes.com/StoryPage/StoryPage.aspx?sectionName=HomePage&id=ac9704c9-3d32-4059-bff2-027b54249147&Headline=Time+to+fix+insurance+%e2%80%94+for+good

Infra-stocks not cheap but see 'earnings upgrades' - Tata

Indian infrastructure stocks are not cheap after a surge since early March, but could see earnings upgrades later this year, making valuations reasonable, the manager of the country's oldest infrastructure mutual fund said.

The environment has turned positive given improved prospects for a push in infrastructure spending after India elected a stable Congress party-led government in April-May polls, said M Venugopal, head of equity at Tata Asset Management.
The fund manager, who oversees about 55 billion rupees ($1.14 billion), including nearly $750 million in three infrastructure funds, said he favoured industrial capital goods, power and construction firms given the opportunity they offered.
"The electoral verdict has given the sector improved visibility and continuity," said Venugopal, whose holdings include engineering firms Bharat Heavy Electrical, Larsen & Toubro and IVRCL Infrastructures & Projects.
"Also, given the uncertain global environment, investors are focused on domestic-led growth and probably infrastructure qualifies the best in this space," he said.
While getting costly and long-term projects finished is the main challenge, the theme will dominate investment in India as infrastructure creation is a key growth driver, said Venugopal.
India estimates it needs about $500 billion to fix its clogged airports, roads and inadequate power supply to continue growing at 9 percent a year to 2012. More than $150 billion of it will have to be funded by the private sector.
The sector suffered a blow last year when the global credit crunch starved Indian infrastructure firms of funds and economic growth slumped.
That led to earnings downgrades, and the BSE capital goods index plummeted 65 percent in 2008, worse than the 52 percent fall in the benchmark index.
Shares have bounced back this year, with Venugopal's Tata Infrastructure Fund gaining 46.9 percent as of June 17, slightly lagging the 50.5 percent rise in the main stock index.


The unexpectedly decisive win by the Congress-led coalition has boosted sentiment towards infrastructure, as government plays a key role in creation of infrastructure and stability gives the government a free hand to implement its policies.
Venugopal's firm is seeking regulatory clearance to offer its fourth infrastructure fund, focusing on small and mid-cap stocks.
He said infrastructure firms could see an upward revision in earnings in the second half of the year to March as the sector benefits from India's rapid urbanisation and rising incomes.
Foreign companies that have set up in India, meanwhile, are demanding better roads and more reliable power supplies.
"Despite all that has been done, there is a significant gap between what is available and what is required," said the fund manager, who also holds shares such as top lender State Bank of India and top cellular firm Bharti Airtel.
"The thrust on infrastructure creation would continue for some time and would require a further boost, which hopefully the government would give," said Venugopal.


Funds to see long-term inflows as loads curbed

* Asset churn by distributors to stop
* New product launches to slow
* Fund investing to turn cheap, transparent
The Indian market regulator's move to ban entry fees for investments into mutual funds will lead to a jump in long-term inflows as distributors adjust their business models to generate more volume and trail fees.
India's stock market regulator said on Thursday mutual funds can not levy any entry charges for investments but allowed distributors to claim a fee for their advise from investors. It also directed them to disclose commissions earned to clients.
"This will certainly help in bringing long-term quality assets to the mutual funds. It will help stop churning," said Chintamani Dagade, a senior research analyst with Morningstar.
More than half of the 1.2 trillion rupees equity assets of the funds industry was less than two years old at the end of March, data compiled by the Association of Mutual Funds in India show, as a result of frequent churning.
This is set to change as distributors, who get an upfront fee from about 2.5 percent entry load that equity funds charge, will now have no interest in making investors switch funds.
Instead, they stand to gain more in the form of trail fees or the money they get from fund houses on continuous basis, if investors kept the money invested longer.
While the changes will hurt distributors revenues in the short-term and limit fund firms ability to gather assets in new funds by paying large upfront commissions out of entry fee, it make investing cheaper and more transparent for investors.
A distributor "would be more interested to keep his trail alive," Abizer Diwanji, head of financial services at consultant KPMG said.
"What it will discourage is unnecessary NFOs (new fund offers) because what was happening is a guy who was earning 2.5 percent commission was interested in churning people from one scheme to the other just to make sure he makes his commission," he added.
FEE STRUCTURE
Some argue it will have no impact as many distributors used to pass bulk of the upfront fees to investors but were paying tax on the entire amount they used to receive from fund houses, effectively negating almost all the gains.
Many distributors were surviving on 30-100 basis points trail fee on the amount of investments they brought for funds.
Now, while they can charge a fee for their service, the onus is on them to add quality to investment advice and persuade investors to pay for it, a task many would find tough.
They may opt to sell products such as insurance which offers many times more commission than mutual funds.
"It is not sure how much they (investors) will be willing to pay," said Krishnan Sitaraman, head of fund services at CRISIL.
"If they are not willing to pay a reasonable level for the services distributors are rendering, then distributors may have second thoughts about continuing to sell mutual funds," he said.
But, in the long-term, mutual fund distribution is more attractive because funds are cheap and easier to sell than insurance and clients would continue to buy them, unlike insurance, which is a one-time investment.
"It is a game changer. The whole distribution is going to change," R S Srinivas Jain, chief marketing officer at SBI Mutual Fund, said.

A load off investors

Once this proposal comes into force, investors may be prompted to immediately
scout for a no/low commission distributor. But that may not be the best course.

Investments in mutual funds may not suffer deduction of ‘entry load’ for too long. In a move that will empower investors to determine the price they will pay for service received from a distributor, thereby reducing their cost of investing in mutual funds, the Securities and Exchange Board of India (SEBI) has asked fund houses to do away with entry load on all their schemes.
Entry load is the typical 2.25 per cent (maximum of 2.5 per cent) charge levied at the time of investing in mutual funds, mostly equity funds. While this may not seem like a conspicuous charge on paper, the levy goes to reduce the final number of units allotted to you. Such levy is almost entirely utilised by the fund house for paying the commission to the distributors for marketing their fund. In other words, a small portion of the money earmarked for investment — in the name of entry load — is paid to the distributor.
SEBI’s new proposals allow investors to directly make payments to the distributors for their services, instead of mutual fund houses deducting the same from the investment amount.
To provide an example: Had you invested Rs 10,000 in a fund which had an entry load of about 2.25 per cent and an NAV of, say, Rs 10 per unit, then, only 977.9 (10000/10.225) units would have been allotted to you, as the entry load of 2.25 per cent would have increased your cost per unit to Rs.10.225.
Under the new proposal, investors would be able to receive units for the entire amount of Rs 10,000 invested; they may have to draw a separate cheque in favour of the distributor towards a mutually agreed service fee.
This essentially means that an investor may have a choice of paying nil/small commission to an ‘no frills’ agent or go for a distributor who charges slightly higher fee, perhaps for other superior advisory service offered in addition. Viewed differently, investor will now be ‘aware’ of the commission they pay; there would be no hidden marketing charges.
Reason behind the move

While this proposal is clearly aimed at allowing the investor to decide what to pay for the service received by him/her, the move may also eliminate gratuitous churning of the portfolio by investors. In an entry load regime, distributors typically benefit more every time a fresh investment is made. Hence, it was not uncommon for distributors to recommend a switch between funds, causing churning.
Now, under the new proposal, the commission to be received by a distributor may be uncertain; the only other key source of the agent’s income would be the ‘trail commission’ received from the fund house for retaining a customer’s investments. So the motive for recommending fresh transactions may be less.
Act with discretion
Once this proposal comes into force, investors may be prompted to immediately scout for a no/low commission distributor. Beware! For one, you may be sold a fund with a poor track record or one on which the agent receives a higher ‘trail’ commission. That may not be the best fund for your portfolio. Please bear in mind that a consistent long term track record and a risk profile that suits your appetite should be the key factors that determine your investment choice.
As we have always maintained, in the Indian market context, an entry load of 2.5 per cent or a commission paid to the distributor is a small sum, compared to the 12-15 per cent annualised return that a good equity fund can easily yield.
Two, if commissions on MFs go down, products such as ULIPs may look attractive from a distributor’s point of view given their lucrative commission. Ensure that you are not sold an ULIP when you do not want one. ULIPs are long term insurance-cum-investment products. They generally build in expenses upwards of 10 per cent, in the initial years. This sum would be deducted from your investment amount.
So as an investor, what should be your response to this change?
As always, ensure that you choose a fund based on its track record. Expenses or commissions come next.
Do not be diverted into buying ‘other’ products if your objective is to buy a mutual fund
If you are a less-informed investor and need advice, do not hesitate to pay a decent sum to a good financial advisor/distributor. There are no free lunches.
If you are a well-informed investor, making your own investment decisions, you can apply for funds directly through their portals or approach any of the local offices of the fund house you want to invest in. This way there would be no commission. If you wish to make such an investment through your online broking account, you may do so; this would however entail paying a fee.
As a distributor has to now reveal the commission that he receives from the fund house for the product, ask him for the same. That way, you will know whether you are paying too high a commission or otherwise.
Note that there has been no indication so far as to the implementation date of this proposal. There are also other grey areas in implementation of the same, especially on the distribution side, which too may have to be addressed.

New packaging of old offers

With the revival of the equity market, the flood of new fund offers (NFOs) has started again. Since May, as many as 12 NFOs have already made their debut in the market. Also, a lot more are expected to follow as many of the mutual fund companies have filed offer documents with Sebi and are waiting for approval.
NFOs are more or less like initial public offerings (IPOs), however, the difference is the fact that money collected through IPOs is for the future growth of a company, whereas, fund invested in an NFO is reinvested in the market for the wealth creation of investors.
From early 2008 till March 2009, the equity markets were not performing well on the back of global economic slowdown. Most of the shares are down substantially and so are the mutual funds’ net asset values (NAVs).
Many of these funds, which are now available at a discounted price from their peaks, have already shown a satisfactory performance in the past. This throws up the question on whether one should go for bottom fishing for existing mutual funds at relatively cheaper prices and proven track record or is it better to get started with the wave of NFOs.
Why old is gold
The first advantage of going with an existing mutual fund is the fact that these are tries and tested. They have a track record. A good past performance, however, does not guarantee the same performance in the future but at least, gives you an idea about the performance of the fund during different business cycles. Here you know about the objective and investment strategy of the fund.
A fund, which has been performing well for a long time, is expected to do well in future, too. According to Krishnamurthy Vijayan, executive chairman, JP Morgan Asset Management, advantage of investing in an existing mutual fund is the fact that you know the track record of the fund. You are well versed with the style of investment.
I V Subramaniam, CIO at Quantum Advisors, agrees with Vijayan. “Existing funds gives the comfort of investing because it carries a track record,” says Subramaniam.
Most of the time NFOs do not carry any new features. Their investment style remains same but, of course, they carry fancy names with new marketing strategies to sell the product. Many of investors follow the general notion that a fund, which has an NAV of Rs 10, is cheaper than a fund, which has an NAV of Rs 100.
However, this is a myth and often used by sales people to hard-sell their products. According to Vijayan, the price of the underlying asset determines the NAV. NAV of an NFO is Rs 10 because the fund has not been invested. As such there is no difference in the price.
NAV is the net market value of the holding securities inclusive of cash, divided by the number of mutual fund units. Hence, a similar increase in the share prices of the holding shares will have the similar impact on the NAVs of both the existing and NFO equally. A fund, which enjoys higher NAV has appreciated in value and that shows the fund’s performance.
If you still find the NFO lucrative, let it pass through the litmus test before you take the buying decision. Before you buy always look back to your portfolio, whether you already possess similar funds. If the fund present in your portfolio has all the major features that the new fund is offering, there is no point buying a new one.
Investment is a long-term affair.
Before you buy an NFO, you must check whether the fund matches your investment objective. Every NFO comes with a new theme - India growth story, infrastructure, diversification beyond the border - however, many a time this may be just a marketing strategy.
Beware of such NFOs. A NFO always lacks the track record and hence, one must check the scorecard of the fund manager of the fund. Look for the performance of the funds managed by the same fund manager. Also, one must keep in mind that during good times every fund does well, the challenge lies in performing during bad times such as 2008. Hence, make sure that funds managed by the fund manager have performed during the crisis.
AMCs make hay while the sun shines and they will continue launching NFOs around different themes — you need to decide whether you want to be carried away by these waves or not.