A recent video of a senior bank executive verbally abusing junior staff, asking them to sell 75 insurance policies a day received attention on social media.

Among other things, it also once again stirred the never-ending issue of mis-selling financial products. While this furore may be related to insurance products, the same is equally true of mis-selling in mutual funds (MF).

Mis-selling by intermediaries has been a long-standing debate in the industry. Recently, MF regulator, SEBI, has gone a step ahead in disclosing it is not just the intermediaries but the AMCs that may be encouraging some of the not-so-desirable practices.

In its recent MF consultation paper (May 2023) that aims at cost rationalisation in the industry, SEBI has provided insights into data that bring out the issues with the product manufacturer – AMC.

Let’s look at these and what the message is for the investor, from these lesser-known facts.

Higher expense

One of the observations that SEBI made in its paper is as follows: “Despite [the] presence of various MFs with significantly large AUMs in schemes which are oriented towards retail investors i.e., equity and hybrid schemes, the TER charged is mostly close to the prescribed regulatory limits. However, in [the] case of debt schemes, with investors being mostly corporates/institutional investors having bargaining power, the TER is much lower than the prescribed limit.

“Therefore, the benefit of economies of scale accruing in the debt schemes appears to be passed on to the investors but not so in the equity and hybrid schemes.”

SEBI observed the weighted average total TER (total expense ratio) for equity schemes came to 2 per cent (as opposed to the maximum allowed 2.25 per cent, that too, on a slab basis). The same was 1.88 per cent for hybrid and 0.77 per cent for debt (as opposed to the maximum allowed 2 per cent)

What the above data means is that retail-oriented equity and hybrid schemes are charged to the hilt in terms of TER. But the corporate-dominated debt schemes have TER much lower than the limit prescribed by SEBI.

Have you ever wondered why your RMs, or distributors, are actively marketing you only equity and hybrid schemes and less debt? For the former products are considered ‘retail’.

AMCs charge as much as they are allowed to and therefore encourage it to be sold to retail investors. No economies of scale are passed to retail investors, it appears.

But with debt schemes, given it caters largely to corporates/institutions (and large institutions can bargain their way into lower TER), the TER is far lower than SEBI prescribed limits.

So, if you are given an equity-heavy portfolio even if your time frame and risk are low, you know the reason behind it is not just the intermediary. It is the AMC too! Does an AMC decide to sell products to investors based on TER or based on individual needs? Think about it.

The switching game

Let’s look at another most popular mis-selling accusation made — that of churning investors’ portfolios, especially during NFOs.

SEBI’s data show 27 per cent of the inflows into NFOs came from switches made from existing regular plans. That is, investors were made to switch to NFOs from ongoing schemes. Overall, 93 per cent of such switches came from the regular plan while it was a negligible amount from the direct plan.

Why do such switches happen? From your point of view, you might think that you moved to a fancied new theme with a ₹10 NAV. But did you know such NFOs in active schemes typically come with high TER? This is because TERs are based on AUM slabs and an NFO does not collect very high inflows all at once.

So, a lower AUM allows funds to charge higher TER for a good while until the AUM grows. And that means AMCs can incentivise their distributors to bring inflows to the higher TER schemes. So, you know it’s not just your distributor, it’s the AMC too!

Of course, SEBI seeks to plus this by proposing that when there is a switch, the distributor will be eligible for the commission that is the lower of the two funds involved. But the bottom line is there is a clear AMC-distributor nexus.

These are but just a couple of examples. The lessons in this for retail investors are simple: you simply cannot outsource your investment decision entirely.

Understanding the financial ecosystem in which you operate is important; in the absence of this, you will see quiet wealth leakage.

I know of many investors who do not know direct plans exist and that there are low-cost index funds available. Either actively considering direct plans or having some element of DIY (do it yourself) or using a good dose of passive products is necessary if you wish to free yourself from these games.

(The author is co-founder, PrimeInvestor.in)

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