The retail investor is not adequately informed about how much he stands to gain by eliminating the distributor.
It is frustrating to see well-intentioned reforms by Indian regulators so easily stymied by red tape or vested interests. The Securities and Exchange Board of India’s (SEBI) new rule which requires all mutual funds to offer a low-cost ‘direct plan’ to investors seems to have met this fate. Two weeks after fund houses dutifully launched these plans, most retail investors are still in the dark about how they work. Instead, institutional investors are making the switch and pocketing the savings.
The argument for direct plans is sound and straightforward — not all mutual fund investors use the services of an agent, and if they don’t, it is unfair that they be charged an annual fee towards the fund’s distribution expenses. Before this rule, funds typically charged a distribution fee of 0.30 to 0.50 per cent a year (on occasion higher), which came out of the net asset value. In a September 2012 directive, SEBI asked funds to stop this practice and by January 1, 2013, open a separate commission-free window for direct investors. It has been three months since this announcement and its rollout, but retail investors still appear to be confused about these plans. The reason for this is clear. Very little by way of communication about the impending change -- or its benefits -- has gone out to retail investors. One cannot expect fund distributors to apprise investors of the change, given that this move strikes directly at their revenues. But it is certainly difficult to understand why fund houses have failed to do this either. All mutual funds have done is to put out statutory advertisements. These are couched in dense legalese, and don’t quantify exactly how much an investor stands to save by going ‘direct’. This reluctance suggests that fund houses value the goodwill of their distributors much more than their investors. SEBI should step in and immediately mandate these disclosures from mutual funds. It can also undertake its own investor education initiative on the new direct plans.
Even such communication, however, may not immediately prompt retail investors to queue up for the direct plans or indeed mutual funds. For one, while direct plans save costs for the investor, they are far from convenient because they entail dealing individually with multiple fund houses. This, in turn, is because mutual funds, unlike stocks, do not share any common platform where investors may transact and monitor their investments. Nor is the move likely to woo retail investors away from other modes of savings. Given that mutual funds have scarcely gone beyond the top cities or affluent investors, most lay investors require the services of a distributor to select the right products, complete the transaction and monitor their portfolios. Therefore, this disintermediation move will at best help the small population of seasoned investors. The task of channelling household savings into mutual funds can only be accomplished the hard way -- through policies that incentivise funds to invest in physical infrastructure.