In order to bring greater transparency and better practices in the Indian mutual fund industry, the Securities and Exchange Board of India (SEBI) recently invited industry's views on its proposal on variable entry load structure.
The proposal had considered two options in order to implement variable entry load structure. Firstly, a section in the application forms where investor would indicate the commission payable to the distributor, which to be signed off jointly by the investor and distributor.
The asset management company (AMC) would then deduct the commission amount from investment made by the investor and pays the same to the distributor. And under second option, investor issues two cheques: one for investment and second in favour of distributor.
The regulator's concerns
The proposal was in line with the capital market regulator’s concern that investors have no control over commission paid to the distributor for investment advice and services rendered to them.
To address this concern as well as to control rebating (a pass-back mechanism whereby distributor pays back some part of his commission to investor in order to compensate for high entry load and also for making investment through the distributor and lastly to build a relationship), the SEBI earlier introduced a zero entry load structure whereby if an investor deposit his investment directly with AMC, he would not be charged for any entry load as he has not received any investment advice from distributor.
Certainly, this didn’t receive good response as distributors did not educate investors about the innovative way to save costs as it will jeopardize his income and there was not much awareness about it.
Distributors were also concerned that under the zero entry load structure, investor would take investment advice from them and deposit application form directly with the AMC.
New proposal's impact
There are various concern areas on the SEBI’s new variable entry load proposal. I think the first choice will lead to beginning of rebating whereby distributor may ask investor to fill the commission rate, which distributor desires and later on pay back some part of the commission to investor.
Also, in most of the cases, distributor fills the application form and investor just sign it off and therefore, distributor may fill the commission amount, which he desires. There is a likelihood of fewer exceptions whereby investor is educated and knows the market around and pay only as he thinks is a right commission rate for the services rendered by the distributor.
Under the second choice, which I believe investor will have control as he would be signing cheques for investment and for distributor's commission. This sounds a good choice to me as investor can now pay an exact fee for the quality of service rendered to him. It is like paying a fee to doctor for rendering his advice.
However, is the investor savvy enough to know how much is right? Retail investors still don’t have much knowledge on entry load and why it is deducted and where it goes. I think there is a need for ceiling on fees, depending upon the size of investment and the quality of advice and research provided.
I am not sure how one can determine after sale service as you cannot determine whether distributor will continue to provide right kind of service post investment. This may be true for big ticket clients as distributor wants to build relationship for additional investments in future, but not same for small ticket investor.
Having said that, the capital market regulator’s continuous efforts to bring transparency and better practices in the mutual fund industry needs to be appreciated.