The Hindu Business Line : Entry load: Unwarranted misgivings

Though the SEBI move to do away with entry loads on mutual funds has raised the hackles of distributors, the decision will serve the best interests of investors over the long term.

Aarati Krishnan

Distributors of mutual fund products have been up in arms against the SEBI decision to do away with entry loads on mutual funds, with some of them even threatening to altogether boycott the funds. SEBI’s move will require fund houses as well as their distributors to completely rework the way they sell to investors and may cause short-term upheavals for the industry.

Distributors’ concerns

However, we believe that this decision will serve the best interests of investors over the long term. We address some of the concerns that distributors have raised over the past two weeks:

Indian investors are not evolved enough to pay a separate fee for financial advise.

Indian investors already pay brokerage or charges on several of the financial products and services that they use. Stock market transactions require payment of a separate brokerage as well as securities transaction tax. Salary earners pay a flat fee to the accountant who files their income tax return.

A good number of people willingly shell out hefty upfront commission to a real estate broker to locate rental property or purchase a home.

This clearly proves that investors are quite willing to pay a fee for a service that they value. Let’s not forget that investors in mutual funds are already paying distributors a fee that is bundled into the entry load. It is another matter that not all of them may be aware of it!

Investors will renege on payments after taking and making use of the advise rendered by the distributor.

There may be one-off instances of this, but let’s not generalise. This is like asserting that all distributors are out to fleece investors, The willingness of an investor to pay a fee will be based on the continuing relationship he shares with his financial advisor.

An agent who pushes an NFO on a one-off basis, only to vanish later, probably has to worry about the investor failing to pay him. But a financial advisor who has a relationship with a client and handles and monitors his portfolio on a regular basis, is akin to a family doctor, and should have no trouble collecting his fee.

Small distributors will slowly die out as they cannot match up to the larger distribution houses.

On the contrary, individual financial advisors may be better-placed than large firms to give personalised financial advice and earn a higher fee for it. Large corporate distribution houses may focus on high net worth investors or collection services alone to drum up volumes.

If the entire fund distribution industry moves to a “zero upfront commission” regime and relies solely on the trail fee to fund its business, smaller distributors could be put at a severe disadvantage.

However, provided the industry adopts a variable fee structure, as intended by SEBI, quality advice and personal service may qualify for a fee that is higher than the present 2-2.25 per cent. The intention of this move is not to have a ‘zero upfront fee’, but to switch to a “variable” upfront fee, from a percentage-based one.

Investors may receive bad advice, as distributors may push products of the larger fund houses which can afford a higher trail fee.

Distributors have, even traditionally, favoured products that offer higher commissions. The hard-selling of new fund offers, as opposed to established funds, is an example. But that hasn’t completely choked off the inflows into funds with a track record and the good funds do manage large asset bases.

The trend of large fund houses being better placed to reward distributors has little to do with the decision on entry loads. Even today, larger fund houses have greater room (given that the expense ratio is pegged to asset size), to offer higher trail fees to distributors. A disclosure of trail fees on all the recommended funds, should in any case, level the playing field.

Solution thru dialogue

Many of the misgivings expressed above can be resolved by the various segments of the distribution industry sitting together and coming up with a constructive solution.

The industry is free to decide on a standard “rate card” for different services that they now render to investors (competitive forces can be relied on to keep the charges reasonable). Services such as collecting the cheque or filling in the application form can be offered at a small flat fee, irrespective of ticket size. For selecting a fund on behalf of the investor or planning his asset allocation, the fee can be pegged much higher. Financial planners who can handhold the investor so that he meets all his long term financial goals, can negotiate a sizeable annual retainer as part of an independent contract with the client.

Fund houses too can play a role by rolling out an education initiative on what mutual funds, especially equity funds deliver compared to competing financial products. The combination of high returns, very low costs and anytime liquidity is surely a hard one to beat!

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