Sucheta Dalal :A Good Move - Unfinished
Sucheta Dalal

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A Good Move - Unfinished  

June 30, 2009



The Securities and Exchange Board of India’s (SEBI) decision to scrap entry load on mutual fund products is a much-needed, solidly pro-investor move. But it has triggered off such a wave of turmoil among distributors that, at the time of going to press, they were planning litigation and demonstrations before the SEBI office in Mumbai and getting ready to lobby the government for a rollback of the decision.
What is all this noise about? In a nutshell, it is just another step towards lowering intermediation charges for mutual fund investors. But, this time, it has pushed large and powerful distributors off the gravy train of fat and easy commissions. SEBI had already scrapped the entry load for direct investment in mutual funds.
Now, it has scrapped the entry load on all funds and has said that commissions will have to be negotiated between investors and distributors and paid separately with full disclosures. Asking commissions to be negotiated is also a positive move, because it follows up an earlier decision by the mutual fund association to bar the practice of distributors passing back a chunk of their commission to large investors.
Before we get into details, let us be clear that all investors have welcomed the move and so have financial planners and advisors who are keen on offering serious advice to customers for a fee. But the decision has dealt a blow to powerful distributors and small investment shops which earned fees of anywhere between 0.5%-2.25% from the fund industry without doing much. In case of new fund offerings (NFOs), the large-scale churning of funds by investors, who were misled by distributors guided only by fat commissions, was a mini scandal. 
Clearly, the distributors’ reaction is illogical. But there is one issue that merits attention. SEBI’s action is welcome if one looks at the mutual fund industry in isolation. After all, it is a fact that the industry has made little effort to reach out to retail investors over the past 15 years. It has grown due to the generous tax incentives offered by the government to encourage retail investment which have been grossly misused as a vehicle for tax-free or low-tax institutional investment. It also generated fat commissions for large distributors such as banks and large brokerage houses, who either became extremely powerful because of their geographical reach, or led to dubious practices to lure corporate investments.
This too has a history. Some distributors used to attract corporate investment into mutual funds by officially paying back a big chunk of their commissions to the client. The Association of Mutual Funds of India (AMFI), in its wisdom objected to it. This only pushed the practice underground and led to cash kickbacks and other dubious forms of gratification of treasury heads of companies. The negotiated commissions/fees proposed by SEBI will now bring much-needed transparency to the fee structure. It will also force distributors to work hard and compete to retain institutional clients by offering better service for lower fees.
R Balakrishnan, Moneylife columnist and a former fund manager, says, “As an investor, I welcome this move.” He says, fund houses do not encourage direct investment for fear of antagonising distributors and prefer to “push NFOs through the distributors, who collect the entry load from the AMC.” He says, “Fund management has been too simple, with no capital required to set up the business. It is a long-term game needing deep pockets to develop a brand and build performance. In 10 years from now, this move of SEBI will be looked at in very positive light.”
True. But, in the short term, it will require a reworking of the business. Initially, asset management companies may be forced to compensate powerful distributors out of their own earnings, until the fee structure is sorted out. They will also have to make plans to educate and reach out to retail investors directly. Similarly, small investment shops, which earned fees by pushing NFOs to retail investors, may also take a hit. 
The only blot in this otherwise excellent scenario is that SEBI’s action may have skewed the playing field in favour of insurance companies who are allowed to pay hefty commissions on unit linked insurance plans (ULIPs) which are hard-sold to gullible investors as mutual fund schemes. The commissions go as high as 40%. Moreover, the insurance industry also continues to reward agents through trailing commissions even when they do not offer any continuing service to investors.
It is all very well to expect investors to smarten up and understand investment products, but consider what an investor is actually up against. Since ULIPs offer hefty commissions, they are in a position to launch high-blitz advertising campaigns which invariably silence media criticism. They also have plenty of funds to put in place subtle, off-the-radar marketing efforts aimed at convincing investors to put their money in ULIPs. This is clearly unfair to the mutual fund industry, but it is an issue that ought to have been sorted out between the independent regulators presiding over the capital market and the insurance industry. Pertinently, there is already a formal forum in the High Level Coordination Committee comprising the union finance secretary, RBI governor, secretary, ministry of corporate affairs and the regulators of pensions, insurance and capital markets.
The statute under which each of these regulators operates makes it clear that investor protection is their primary responsibility – why then is there no consensus among them on investor-friendly issues such as fees, commissions and intermediation costs? 
While one welcomes SEBI’s move, it would have been a lot less controversial if the regulator had examined the larger picture and spelt out a transition process. For instance, as AK Narayan of the Tamil Nadu Investors’ Association points out, nobody is clear if an investor will pay a separate cheque for the commission which, he says, is simply not feasible. Surely, the regulator also understands that only large, institutional investors can negotiate fees. Retail investors, who are supposed to be the mainstay of the mutual fund industry, have no clout to negotiate anything.
Retail investors now have two choices – they will have to learn to understand investment products, instead of depending on outside advice, and can opt for the direct investment route. Or, they will have to learn to pay for investment advice and may end up having to sign up for such advisory services. In the latter scenario, investment advisory services that are initially hit by the scrapping of entry loads will be able to rebuild stronger businesses, while investors too can hold them accountable for the quality of their advice. This is again good for the long-term health of the market – it will ensure that the mutual fund industry pays attention to investors instead of being driven by distributors.

-Sucheta Dalal

-- Sucheta Dalal