07 July, 2009

Muzzling MFs puzzling

In life, some boys keep getting bullied… they are probably the meeker, weaker ones or those that don’t protest. These boys are taunted endlessly and they become introverted & reclusive. That could be the Mutual Fund Industry, which is facing it’s survival test today. It has been pushed into a corner now and is looking helplessly into a future that looks black & darker shades of grey.

How did it come to such a pass? The various constituents of the financial services industry are under different regulatory bodies like SEBI, IRDA, RBI etc. Now, different regulators have different views of furthering the industry’s cause, investors’ cause…SEBI has been looking at everything from investor’s point of view only.

One of the latest regulations for MFs, was Zero entry loads for direct investments. The logic was that those who did not want or do not avail of any advice need not be made to pay any loads. But it makes better sense in insurance products in view of the much higher commissions. And the same should apply to company FDs, Post office products PPF etc. as advice here is minimum or nonexistent.

Another logic given was that in US entry loads are less than 0.5%. Not true. There are no-load funds as well as other actively managed funds which charge low to very high entry loads. Legg Mason Partners Dividend Strategy Fund ( US$1.6 billion ) charges an entry load of 8.5%. Evergreen Omega Fund A is one of the top funds, according to Lipper, charges Front-end load of 5.75%. US Blackrock Basic Value Fund ( US$3.3 billion ) charges 5.25% entry load. There are 1971 funds which charge entry loads between 4-6% in the US… another 143 funds charge between 2-4%. Even very large funds such as US American- The Growth Fund of America ( US$131.4 billion ) charges 5.75% Entry load. The funds pay the distributors there too.

Then, now we have this proposal for abolishing entry loads altogether, in all funds. We already have a direct route, where there is no entry load. Hence, if the investor did not want any advice, he could save on the entry load. When this option already exists, abolishing entry loads by fiat, reeks of biased targeting of MFs & their distributors. What is sought to be introduced here is a new, untested architecture which SEBI feels is good for the investors and the markets. It is not possible for all distributors to become consultants overnight and be confident about charging fees.

It’s ironical, as MFs are an ideal route for retail investors to participate. Muzzling the industry and tying it up in knots, is hardly the way to facilitate broad investor participation.

One of the explanations is that they want a level playing field for all players, big & small. They say it is unfair that big operators get bigger commissions for doing the same work. It is an accepted practice in intermediation. In any industry ( across the world ), the ones that bring in more business gets a higher commission. As long as the higher commission is paid by the AMC ( entry load in most cases is 2.25% only, whether it is a big or small distributor ), why is it such an irritant? Why does a stockbroker ( also coming under SEBI ) not collect a separate fee and charge a brokerage? Wouldn’t their investors want to pay them based on the advice rendered?

The other legitimization sought for introducing this proposal is that distributors would sell products that give them maximum commissions and not the one that is best for the investors. A distributor can anyway take the money away to a ULIP instead of a MF scheme and that is already happening now, looking at the accretions to Insurance companies. Secondly, investor education is important. They need to know broadly if their investments are going to the right places, if they want to be on top. This is an area SEBI needs to work on. Thirdly, commissions offered are within the framework set by SEBI.

This proposed system will necessitate negotiating with each client about the amount he would pay as fees. This itself is a tortuous process, which will increase the work for distributors. It is not going to be easy for distributors to get their clients to part money, every time they invest. The amount involved may be low, like twenty rupees. There will be hundreds of such small transactions for which a distributor will have to now raise bills, which will again be onerous. Handling fees for SIPs, poses a different level of problem.

This proposal has been put forth with the idea of pushing distributors towards the fee model. But, what about the others? There is no level playing field. All other constituents do not come under this legislation. Hence, immediate upshot would be that ULIPs will get sold more as distributors sell all products and this legislation for MFs will only force their hand to sell ULIPs and others instead. Even NSCs or KVPs will be sold instead of MFs. So, where does this leave investors?

Investors may be elated now, thinking that they can squeeze and get more from their distributor. But any win-lose relationship will not work. Distributors will move on to other areas, if they are not wanted here. Accretion to MFs will definitely be affected. MFs will no doubt come up with some ideas on remunerating distributors, even in this constricting regime. But then, MF industry is now running with it’s hand tied behind. It’s a battle for survival.

A level playing field is required for all players in Financial services. That will be fair and will ensure that all participants have an equal opportunity to place their products before customers. If investor’s interests are the ones that SEBI seeks to protect, then this legislation is in the wrong direction.

Published in DNA Money on 2/7/2009

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