The Hindu Business Line : Sharp practices

THAT THERE WERE sharp practices in the distribution of the mutual fund products is not a surprise, as mutual fund houses and their retailers have resorted to a variety of incentives to lure money to their care. As high net worth investors are pursued, inevitably there is some discrimination between them and small investors when distributor-level largesse is doled out. Anyway, high net worth investors who can invest large sums are exempt from entry load in many income and equity funds. In this backdrop, the `sting-study' by the Association of Mutual Funds of India (AMFI) only confirms the existence of marketing practices that do not necessarily serve the interest of investors.

What is disturbing is that fund distributors are positioning products as offering `guaranteed returns'. After the fiasco of the assured return funds of the erstwhile Unit Trust of India, the industry has generally moved away from such products. This aspect makes the marketing strategies of distributors even more questionable; to an extent, the fund houses are as much to blame as it is unlikely that such practices are going on without their knowledge. Apart from investors who are led up the garden path, it is the fund houses that stand to lose the most over the long term; when investors find that there are no guaranteed returns, they are likely to shun the fund house. The distributor may even have faded from memory; even if not, he is unlikely to be in a position to undo the damage.

These practices of distributors also affect investors by pushing up mutual fund expenses. Fund houses place the cost of distribution and marketing as the prime reason for their recurring high-expense structure. Thus, the retail investors, who invest modest sums, end up footing the bill. This was not a problem till recently as the steadily declining interest rates boosted bond prices and returns from debt funds masked the high expense levels. No longer, as returns have plateaued. Mutual funds should ensure that their distributors market the products based on investment performance. The commission paid to distributors should only cover costs, a mark-up and modest incentives for performance. Fund houses should also position their products, especially income funds, at specific investor groups. Allowing a mix of retail and institutional and high net worth investors can only encourage distributors to go for the big fish even it means forking out incentives on their own.

The Securities and Exchange Board of India, the AMFI and the fund houses should put in place stringent penalties for non-compliance with regulatory requirements as well as for any effort by distributor that misleads investors. The AMFI has done well by conducting a sting operation to confirm the existence of practices that are inimical to investors and fund houses. It has to push for changes in the regulatory framework to ensure that a key link in the fund flow chain — the distributor — does not end up denting the gradually reviving investor confidence in mutual funds.

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