The Securities and Exchange Board of India (SEBI) in its board meeting today decided there would not be any entry load applicable in any of mutual fund scheme.
The upfront commission to distributors would be paid by investor directly, the industry regulator has said.
Currently, the entry load is applicable primarily on equity funds.
SEBI had early this year sought suggestions from industry stakeholders on its proposal on a variable load structure. The objective of the variable load structure model was to bring greater transparency and better practices in the Indian mutual fund industry.
The proposal had considered two options in order to implement variable entry load structure.
First, a section in the application form where investor would indicate the commission payable to the distributor, which would 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 pay the same to the distributor.
Under the second option, investor issues two cheques--one for investment and second as a commission to distributor for his/her advice.
The regulator adopted the second option whereby investor would now pay directly to the distributor.
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.
Under the current structure, the distributor is paid entry load on business mobilized by him.
Since the entry load is around 2.25%-2.5%, the cost of buying a mutual fund product was higher and therefore, distributors also resorted to passing back some part of his commission to investor, a practice called as rebating. This also helped distributor in mobilising more business.
Under the new regulations, distributor would have to disclose commission and trail income received from the investor/asset management company.
As expected, the distributor community is not happy with the new regulation.
Distributors believe there would be increased competition and their commissions would come significantly down as distributors would quote lower commission in order to get business.
Sub-brokers and individual financial advisors (IFAs) would also get impacted as they primarily depend on upfront commission. Also, large-sized investors would negotiate hard to reduce commission payable to distributors.
We believe investors would now have the choice to decide which distributor to choose for advice on his investments, depending upon the quality of advice and services rendered by the distributor.
Initially, it may be a difficult exercise for a new and less informed investor to decide how much commission to be paid to the distributor and therefore there are chances of mis-selling. But we believe the market would discover the price and practices to be followed for the long term existence.
SEBI’s new initiative is a step in right direction as it will bring more transparency and better practices in the mutual fund industry.
Though, in the short-term, the industry would feel pressure as for IFAs and sub-brokers mutual fund business would no longer be attractive proposal and they are likely to shift their focus to insurance and other investment products.
The role of banks, certified financial planners, and large scale distributors would become important. However, we think these distributors would focus more on corporate, small and medium enterprises, and high net worth individuals for providing their services as these investors have higher investment surplus.
There are a few questions that come to our mind. Who would look at small retail investor (less than Rs. 5 lakhs) now? Will mutual funds by themselves be able to penetrate into retail markets as they wished at the recently convened CII Mutual Fund Summit? Will mutual funds increase trail commission in order to keep mutual fund business attractive for sub-brokers and IFAs, who mainly penetrate into retail markets? If so, AMCs' expenses would go up, which would hit their bottom lines. Currently, the trail commission paid to distributor is 0.5% p.a. of assets under advice, paid on a quarterly basis.
The mutual fund industry is waiting for the capital market regulator to provide more thoughts on its new directive, which would be out soon.
Another thought: is the regulator over intervening in an industry, which is at a nascent stage, being only 7.7% of gross household financial savings coming into mutual funds as of FY 2008?
This percentage is quite higher in developed markets like U.S. and the U.K. In U.K., 26% of gross household savings come into mutual funds, while the ratio in the U.S. is around 80%.