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With the Sensex rising 25 per cent in the past year, new equity funds are back in vogue, collecting nearly ₹6,400 crore in the first nine months of 2014.
But curiously, closed-end funds, in which investors have to lock in their money for 3-5 years, have attracted the bulk of these inflows (₹5,000 crore). For instance, ICICI Prudential MF collected about ₹3,000 crore across its Value Series 1-5 and Growth Series 1-3 new fund offers (NFOs), launched periodically since November 2013.
Why are closed-end funds so popular? Some market watchers believe high up-front commissions for distributors on closed-end funds, between 4-7 per cent, are driving collections.
In 2009, market regulator SEBI had banned up-front incentives for distributors from investor money. After the ban, the industry moved to the practice of compensating distributors more through ‘trail fees’, annual fees paid for the period an investor stays with the fund.
In cases where the asset management company (AMC) still paid an up-front commission out of its own pocket, they were at a moderate 1 per cent of assets.
However, many recent closed-end NFOs have paid up-front incentives of 4-7 per cent, with the AMC footing the bill. “There is nothing wrong with paying up-front commissions to build one’s business,” explains the CEO of a leading mutual fund. “But the cost of acquisition of a customer goes up. So, the assets have to stay for the long term to help fund houses benefit.”
But the high up-front fees have attracted the ire of both SEBI and industry body AMFI. Concerns about up-front commissions are two-fold. One, since they have to pay the entire commission, only AMCs with deep pockets will be able to sustain the payouts.
Secondly, the high commissions may lead to mis-selling. Some recent closed-end launches focus on high-risk small- and mid-cap stocks. If these bets don’t pay off, the investor has no way to exit during the lock-in.
Anil Rego, CEO of Right Horizons, a personal wealth management firm, says high up-front commissions would definitely lead to mis-selling as it is only in the euphoria of a bull market that distributors can cash in.
Distributor Tanwir Alam, CEO of financial portal Fincart, says moving to a full-trail model will also be good for distributors.
“Independent financial advisors who want to create a long-term investment book and run a sustainable business will prefer trail commissions. It is distributors who run retail shops at high cost or distributors such as banks that will seek high up-front commissions,” he says.
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