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?
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)