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Understanding the crisis in mutual funds sector

S.N. Krishnamoorthy
Comment (10)   ·   print   ·  

Instead of doing away with entry loads and squeezing distributors, the solution is to restore these commissions ...

Entry load on mutual funds (MFs) was done away with, following the uproar over the burden that it places on the investor.

However, with its abolition distributors’ commission has come down drastically. The commission paid to them is not good enough to motivate them to garner more business for MFs. Hence, it is hardly surprising that the MF industry is in the doldrums, worrying policymakers right up to the Prime Minister.

During his recent, brief stint in the Finance portfolio, the Prime Minister sent signals for the re-introduction of entry load. But this move was opposed by Securities and Exchange Board of India Chairman U K Sinha on the ground that introduction of entry load in MF schemes would burn a hole in the pockets of investors.

While opposing the introduction of entry load, Sinha has not suggested any solution for the waning business of MFs.

He has acted typically as a regulator, and not as a development authority. Whereas the Insurance Regulatory and Development Authority functions as a development authority, the MF industry does not have any such institution to look into its interests.

In adopting a regulatory outlook, however, Sinha is not alone. But Sinha, as well as a host of analysts, have overlooked the basic issue: while the distributor needs a higher commission to promote the industry’s interests, why should the investor pay for it? The problem, in other words, needs to be reformulated.

THE REAL PICTURE

Why should investors bear the incidental cost (distributors’ commission), when it is the MFs which want to increase their assets under management (AUM)?

Statistics shows that the AUM, especially equity AUM, dwindled after abolition of entry load. This does not mean that investors are keeping their money idle.

They have a plethora of avenues to park their funds. Even if they choose to invest in MFs, they have umpteen choices. MFs need investors, rather than the other way around. During the era of entry load, MFs would take the money (entry load) from investors and pay the same to the distributors as commission.

Now the picture is clear. For the survival of the MF industry, AUMs need to grow, for which MFs rely on distributors.

Distributors have a wide range of contacts with retail investors in particular, and can be more effective than the sales personnel of the MF industry. MFs can bring more business by paying commission to distributors. But who should foot the bill — the investor, by paying entry load, or the asset management company?

To reiterate, it is pretty clear that MFs need a good quantity of AUMs for their survival. However, investors need not rely only on MFs; they have other investment options such as gold, real-estate, bank FDs, to fall back on.

In such a scenario, the service rendered by a distributor is for the survival of an MF and not for the sake of an investor. Why, in that case, should the investor bear the burden of paying commission to the distributor?

UNDERSTANDING ROLES

Let us look at this another way. In all MFs, sales employees are paid the most, after fund managers. A middle-level sales employee gets Rs 10 lakh per year (cost to company). His job profile is to mobilise business. And, he is paid a salary, by the AMC, irrespective of whether he brings a commensurate level of business. Distributors are also doing the very same job, for a commission.

Sales staff are on the AMC’s rolls, whereas distributors act as off-the-rolls employees. It then defies logic that employees’ huge salary outgo should be met by the AMC and the distributors’ commission be paid out of investors’ money. In fact, the cost of procuring business is higher in the case of employees than distributors.

Distributors are accused of churning the investment of their clients quite frequently to increase their commission. Here, SEBI assumes that investors are financially illiterate and dance to the distributors’ tune.

This is absurd. Generally, it is investors who choose to exit from one MF and enter another, to maximise their return. The very basic tenet of equity is that its value changes every second and tracking the equity market by switching MFs is only to be expected. Are not fund managers churning portfolios often to improve a fund’s return?

Then, what is wrong if investors do this? If investors want a long-term investment, then they will go for gold, real-estate and bank FDs.

Unlike earlier, it is a buyer’s market for MFs these days. Currently, MFs are badly in need of distributors’ service to enhance their AUM and survive the cut-throat competition. They need to pay a commission that compensates the expenses of a distributor in bringing business. The commission should be paid by the AMC from its pocket, without charging entry load.

There is no need to reintroduce entry load. But there is certainly a need to pay the distributor a higher commission.

(The author is a Chennai-based freelancer)

(This article was published on August 3, 2012)
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Comments:

The author's concern about distributors is understandable. But what has he to say about investors interests? In order to protect interests of investors of a MF scheme wherein a few large investors may be dictating terms to the AMC albeit indiscreetly, SEBIs role as a regulator is very crucial. If Mutual Fund (MF) industry has to survive and grow, it has to do it on its strengths and not with the help of any sops. The basic objective of investing in a MF scheme is to provide an opportunity to investors to diversify their risks. If MF schemes fail to deliver good results because of a sluggish economy or due to market volatility or on account of poor performance of fund managers of the concerned Mutual fund schemes, eventually the MF fund house will have to make an exit. In this connection, my query is whether in our country there are too many MF houses vying for a limited number of investors. If that is the case, it may be necessary to re-consider entry norms for new MF houses.

from:  Narendra M Apte
Posted on: Aug 4, 2012 at 09:18 IST

the author has hit the nail right on the head. SEBI has also been assuming that mis-selling is being done by the IFA's whereas it is the institutional distributors who do the same. Further, the cost for the IFA works out higher than the insititutional distributor. While the institutional distributor has an almost ready database and applications and forms are collected by the AMC, the IFA have to really slog for their business with umpteen visits to the client, collect and submit the forms to the AMC or the RTA. Another point to be noted is that even a small no of mis-selling by the institutional distributors has a huge effect in money terms.

from:  Pradeep hattangadi
Posted on: Aug 4, 2012 at 10:04 IST

Equity mutual fund collections have come down due pure equity market performance and not because of abolition of entry load. Mutual funds houses have the habit floating numerous schemes, where the fund deployment between majority of the schemes are identical. Then why there is a need for floating new funds. That is just to mobilize fresh funds. This is not correct. They should try to educate the investor about investment benefits and collect money. Mere increasing the sales commission to the distribution will lead to mis-selling like what is happening in insurance. Funds house can collect fund management charges and pay distributions out of that. That is only our good option from the investors point of view. It should be in our mind that only if investors are happy about their investment they will come and invest more. Hence investor interest prime important for the development of mutual fund in the long run

from:  Senthilnathan
Posted on: Aug 4, 2012 at 10:15 IST

From the article it is clear that mutual fund investments are treated as short term investments like direct equity both by the investors and the distributors whereas class room teaching emphasize that equity or the mutual funds are long term investment vehicles. This is where the problem arise.

This is the root cause of all the problems for MF Industry. They, despite their presence of around 2 decades could not place even this point into investors/distributor's mind firmly then how can they expect to grow.
Industry should therefore focus to educate the distributors and investors alike on this particular aspect, not by words but by deeds and show the real benefit to investors to attract them. On paper MF equity schemes have excellent past performance but in reality very few investors have reaped the rewards. Find the reasons, address them effectively and see, if Industry grows or not.

from:  Kamal Singhi
Posted on: Aug 4, 2012 at 11:52 IST

I read this article and have following comments to make.

I am a mutual fund investor. I am influenced to invest in a mutual fund based on its performance. If the mutual fund gives good return, investment will be amde. Whether the distributor markets the product or not, the investor looks at the return. If the proeduct of the investment house has a poor track record, no investor will invest even if mutual fund distributor makes fancy claims. I have myself invested in Kotak indoworld infrastructure fund in 2007 and in 2012 the fund gave negative return. the fund never generated a positive nav during the five years of investment when the market moved up and down. Will I ever invest in any schemes of Kotak? No surely not. Even if the mutual fund distributor makes tall claims about this fund house, I will not touch the schemes of this fund house. Like me many investors will have complaints against this fund house. What matters is performance. Performance will speak for itself.

from:  rajendra modak
Posted on: Aug 4, 2012 at 15:13 IST

One fails to see the logic of investors having to pay for the health of MF industry. They shd fend for themselves or quit. Perhaps MFs shd reduce the sales people engaged on salary and pay distributors directly on commissions as this is said to be cheaper. Funds bought thru distributors should have an entry load. This should be publicised. MFs shd invest in efficient free online transactions. I am sure in no time people will make effort to learn how to make MF investments online. MFs will find no need of distrbutors.

from:  sandip
Posted on: Aug 4, 2012 at 16:47 IST

I have been a regular Mutual fund investor for a decade and I would
disagree with the premise that inflows into MF industry is down
because of banning of entry load. The real blame should fall on these
very distributors and the big MF houses which were all along colluding
and mis-selling wrong products to gullible investors. Distributors
were promoting Mutual funds on the basis of the amount of commission
they got rather than the quality of the product and MF houses were not
transparent in their relationships with the distributors. The end
result was that investors lost their savings and their trust in mutual
funds came down. So how do bring back the investors? I would say more
transparency, more customer friendly method of investing like online
purchase and lesser costs to the investors,ie.no entry load and other
hidden charges. Quantum Mutual fund is an excellent example that
mutual Funds can give very good returns without having entry load and
distibutor dependance.

from:  NBA
Posted on: Aug 4, 2012 at 21:13 IST

Excellent article. Why should a investor pay for distributor commission?
let the MF open branches and market their product thru their own
channel. we can seen best performing funds always get investor
confidence and keep growing. its the worst performer that gets out.
introducing the entry load will incentive distributor to move money
around highly incentive paid funds rather than best performing funds.

from:  Bharat
Posted on: Aug 4, 2012 at 21:53 IST

Regulators seem to have a notion that they are there only to use the
stick. They do not know that carrot diplomacy should also be used for
the development of industry. They also have a wrong notion that there
is very big rush for MF investment Now the question is why anyone
should invest in Mutual Fund, where nothing is certain, and nothing
assured. The investor may loose his entire investment also ! Is SEBI
giving any assurance to the investors regarding repayment/returns ? Too
much was expected from Mr.Sinha, But he also proved blank. Now it is
not that easy to revive MF industry back to its old glory. Even if the
upfront is reintroduced, the Distributors may not be in a position to
easily sell because now investors have lost the confidence in MFs. To
make the things easy, scrap SEBI, scrap KYC, ask for only Pancard or
form 60. Mr.Sinha should retire.. AMCs are accepting deposits and not
giving loans. Then why so many papers. Do they not have confidence in
the PAN CARD ?

from:  Boodugere Nagaraj.
Posted on: Aug 4, 2012 at 21:57 IST

SEBI has to increase the entry barriers for AMCs from the present level to higher Networth so that all and sundry should not be allowed to enter the Mutual Fund industry.At present it is too crowded. Instead of intermediaries AMCs must have permanent staff to mobilise and market their products and do away with commission or trailing commission similar to the Banks.Commercial and cooperative banks are not paying any commission to procure deposits from the despositors.The total deposits of the commercial banks is more than Rs.61 lakh crores even without paying any commission and that too without many varieties of products.The bank deposit products are mainly Fixed with monthly interest or compund interest and Cumulative/Recurring DepoistsSavinfs and Current deposits.MFs must do away with various products and must have only 4/5 only.Bank deposits are increasing every year by more than Rs.7 lakhs per year which is more than the total AMUs of all the AMCs of the entire Mutual Funds industr

from:  SHETTY.K.V.
Posted on: Aug 5, 2012 at 08:01 IST
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