The MF industry must brace for more change

At the AMFI (Association of Mutual Funds of India) 2018 summit in August, HDFC Chairman Deepak Parekh and SEBI Chairman Ajay Tyagi did some plain speak and hard talk. Both highlighted the huge growth potential of mutual funds, and then quickly moved on to areas of improvement for the industry. The litany lists were long and likely wasn’t music to the ears of many in the audience, mainly fund house personnel and distributors.

In less than a month after the AMFI summit, some big changes with far-reaching implications have already been rolled out. Last week, SEBI slashed mutual fund expense ratios, banned upfront commissions to distributors and disallowed asset management companies (AMCs) from using their own funds to incentivise intermediaries.

Good news

The cuts in expense ratios will improve returns for mutual fund investors while reducing the incomes of fund houses and distributors. The trail-only-commission model is meant to align the interests of investors and distributors, and curb mis-selling and unnecessary churning. Insisting on expenses being borne out of the scheme corpus and stopping AMCs from using own funds to incentivise intermediaries will likely stop, among other practices, expense-paid holidays for distributors. This problem area, Parekh had said, leads to bias in distribution.

SEBI has also effectively clamped down on closed-end schemes by squeezing their expense ratios. Many of these schemes serve little investor purpose while increasing fund houses’ assets under management (AUM) and paying big commissions to distributors.

These moves were long coming. SEBI had hinted many times on the need to improve investor experience and moderate fund expense ratios; especially because the rapid rise in funds’ AUM over the past few years would have translated into sharp income jumps for fund houses and distributors. Investors, SEBI reckoned, deserved lower costs and, thereby, better returns. And rightly so.

Going by the speed and extent of the changes brought in by SEBI, the mutual-fund industry must brace itself for more. Tyagi had pointed out that with rapid growth, better risk management and regulation become extremely important for fund houses, especially in the case of debt mutual funds. As if on cue, the recent debt fiasco at IL&FS, that saw even many liquid funds take a knock, attest to the validity of Tyagi’s assertion.

Liquid funds are often positioned as an alternative to savings bank accounts, and so capital loss, even if temporary, on such funds erodes investor confidence. With AMFI having ambitious plans of launching a ‘Debt Funds Sahi Hai’ campaign on the lines of the hugely successful ‘Mutual Funds Sahi Hai’ campaign, IL&FS type of episodes do not bode well. SEBI might again step in with tighter regulations if fund houses keep falling short.

On direct plans, Tyagi said that they had many advantages including lower costs and lower mis-selling. Pointing out that advertising of these plans was still a low-key affair, he said there was a strong case for both SEBI and AMFI to promote direct plans. Over the past year or so, many new players have started offering direct plans, Paytm Money being the most prominent new entrant in the business.

Direct plans may be suitable only for savvy investors, but Tyagi’s point about low awareness and publicity of these low-cost schemes, which have been around for more than five years now, is valid. While fund houses’ soft corner for regular plans that are sold through distributors makes commercial logic and is understandable — these bring in the chunk of their AUMs — they should also make investors more aware about direct plans.

Tyagi also highlighted the high concentration of the industry among a few players, with just four fund houses having 50 per cent and seven fund houses having 70 per cent of the industry’s AUM. This skewed distribution is also reflected in the revenue and profit share of the players. Some thinking, he said, was required to facilitate healthy competition in the industry. Could such contemplation eventually translate into more incentives for smaller players to scale up faster and compete with the big boys?

Managing trust

Bad financial decisions often happen in good times, Parekh said, warning about the risks to investor confidence from even a few fund houses that deviate from good governance norms. Pointing out that fund houses are trustees of public money, Tyagi said that some recent instances don’t speak well.

While not explicit, this could be a reference to ICICI AMC bailing out the initial public offer of ICICI Securities and SEBI eventually directing the AMC to refund the money to the schemes that had invested. HDFC AMC’s pre-IPO share allocation to distributors, which was also eventually rescinded by SEBI, did not show the industry in good light.

The many cases of balanced funds masquerading as ‘guaranteed’ dividend products in the not-too-distant past also show the industry in poor light.

“Pyaar aur bharosa dheere dheere badhtha hai,” rounded off Tyagi, stressing that integrity and good conduct in the industry is very important. The industry and its participants would do well to pay heed to sane advice.