The capital market regulator’s decision to scrap the entry fee on mutual funds from 1 August is set to alter the way the business is done in India, according to asset management companies and distributors that are now grappling with ways to deal with the looming change.
For one, while the move by the Securities and Exchange Board of India (Sebi) was meant to benefit the investor, the change does not necessarily mean a free lunch.
Distributors are devising ways to provide value-added services so that they can charge a fee for advising clients on financial goals instead of just hawking a product. A corollary to this could be that middlemen would focus only on high net worth individuals and wealthy clients, leaving the smallest consumers with no option to access fund services.
Secondly, the onus of getting the commission now passes from the asset management companies to the distributors themselves. Entry loads, which are capped at 2.25%, are typically passed on to the distributor by the asset managers. When a consumer invests Rs1 lakh, less than Rs98,000 is actually put in the fund. This is about to change now, as Sebi says that distributor fees should be paid in a separate transaction and the entire money that is given for investing should go into the fund.
On 1 July, Sebi said that funds may no longer charge an entry fee for a mutual fund scheme. It also tighetend the rules for exit loads, which are 1-5% of the assets under management. This amount is typically used to fund marketing expenses, a part of which is distributor commissions.
Now Sebi says that only up to 1% of exit fees can be used for marketing expenses.
“The pie is certainly smaller,” said Dhirendra Kumar, CEO of ValueResearch, a New Delhi-based mutual fund tracker. “We might even see distributors ask for more trail commissions.” Trail commissions are paid at the end of every year to distributors, and this is part of the expenses fee of the asset management company.
The Indian mutual fund industry has assets under management of Rs 6.7 trillion and about 87,000 registered agents sell mutual funds in India. These agents earned around Rs75 crore in the last financial year as entry load fees, according to a back-of-the-envelope calculation.
The previous year, one exceptionally good for equity inflows, saw them earning four times this amount. This is the money that Sebi has targeted.Some of the ideas that are floating ahead of the change in regulations include assets under management, or AUM-linked fee structures, where the distributor-turned-financial adviser gets a slice of the profits and bundling of services, especially by banks.
Some technology companies and the mutual funds business grouping, the Association of Mutual Funds in India, or AMFI, are introducing online platforms, which will help these financial agents aggregate data and provide better advisory services.
“It’s a new environment. People will have to move from distribution to advisory model,” said Jaideep Bhattacharya, chief marketing officer of UTI Asset Management Co. Ltd.
For that to happen, however, the army of distributors, most of whom just push mutual funds (as upfront fees make up the majority of their income), have to be trained. They have to have access to data and financial tools which will help them advise the customer on meeting financial goals.
This is where online platforms come in, said Rajesh Krishnamoorthy, managing director of iFast Financial India Pvt. Ltd.
Online platforms such as Fundsnet, iFast and Njfunds allow financial advisers to plug into and avail an array of services. These take care of the entire back office requirements of the distributors such as aggregating details of investments in various schemes and periodic statements besides offering them data and other investment advice, which can be used by financial advisers during their interactions with the clients.
“The writing is on the wall. The onus is on the distributors to create an ownership of customers by improving the quality of services. Platforms can be one way of doing it,” said Avinash Ramnath, national sales head of Canara Robeco Asset Management Ltd.
However, asset management companies cannot completely wash their hands of distributors either, cautions Sanjay Santhanam, who recently quit working as marketing head of Sundaram BNP Paribas Asset Management Co, and is starting a financial services firm.
“Mutual funds are dependent on distributors. And, when insurance agents work at double-digit commissions, and in a society where awareness about funds is low, it’s important not to throw the baby out with the bath water,” he said.
Upsetting equilibrium?
Mutual funds have traditionally griped about competition from unit linked insurance products or Ulips, that provide insurance cover and invest part of the premium in stocks and bonds. Life insurance firms do not have a standard method to calculate charges included in Ulips and as such distributors sometimes earn as much as 50% of the first premium as commission on these products.
Indeed some distributors such as Anagram Stock Broking Ltd say that they are now focusing on insurance.
“We are not going to sell MFs. For any product to be successful, there needs to be an equilibrium between distributor, consumer and the regulator. The latest Sebi ruling has upset this. Distribution cannot happen free,” said Sudeep K. Moitra, the company’s chief distribution officer.
Last financial year, Anagram said sold mutual funds worth Rs100 crore, of which 60% were retail transactions of less than Rs10,000 and Moitra says he couldn’t cover his costs with this.
If distributors turn financial advisers, then there is also a danger that they would marginalize small investors, especially those who are not literate or lack the savvy to log on to direct trading platforms.
“Those who are giving advice and who have been able to grow the investors’ money will continue to enjoy the confidence of investors, ” said N.N. Kamani, vice-president, marketing, Dhruv Mehta Investment Advisors, whose clientele is largely high net worth individuals.
From the asset management companies’ perspective, one way of dealing with the situation is to create an AUM-linked compensation structure with some big distributors. Thus, if a financial adviser-distributor helps a consumer grow assets by astute selection of mutual funds, the customer would pay him a slice of the profits. This is just another way for distributors to collect trail commissions, but directly from the consumers.
Changing investment norms
• What is an entry load?
This is the price an investor pays to buy a mutual fund (MF) unit. It is currently capped at 2.25% of investment. So, if one buys an MF unit for Rs100, only Rs97.75 is invested in the fund.
• Where does the balance Rs2.25 go?
A major part of this amount is paid to the distributor. Some fund houses use part of it to manage the fund, pay salaries of fund managers, meet administrative costs of sending monthly and annual return statements to investors and so on.
• Why is everybody talking about entry loads now?
They will be scrapped next month. Sebi has said investors can pay the distributor whatever they want as commission, but separately. This means that when one buys a mutual fund unit for Rs100, one invests Rs100 (and not Rs97.75).
• Does this mean investors will buy funds for free from August?
Not necessarily, but the agent commission may come down. The agents who normally hound investors to redeem money from existing funds and invest in new funds will not do that any more as they will no longer get upfront commission.From August, financial advisers will guide investors through a range of financial products. Indeed, they will charge fees for these services, but that’s a matter of negotiation between the investor and the adviser.
• What else does Sebi say?
Funds can use only 1% of exit loads for marketing expenses (even if they charge more).
• What is an exit load?
This is the price one pays for prematurely exiting the mutual fund. Asset managers charge 1-5% of investment (valued at current market prices) when one quits the fund. So, if the investment is valued at Rs100, at the time of premature redemption, one may get only Rs95.The penalty varies with the duration. So, the longer one stays invested, the smaller the exit load.
• If a fund is charging Rs5 as exit load but can take only Re1, what happens to the balance Rs4?
According to the new rules, the asset manager has to sink this into the fund. Following this, those who remain invested in the fund get the residual benefit of someone else’s investment.
