06 December, 2010

How thw capital market regulator paved the road to perdition for Mutual Funds

Data can be made to lie. The top brass at the Securities and Exchange Board of India (Sebi) has claimed an inflow of `65,000 crore to mutual funds during 2009.

The fact is, assets under management (AUM) of the mutual fund (MF) industry have been coming down since August 2009. From a high of Rs8.03 lakh crore, the average AUM declined to `7.13 lakh crore in September 2010.

The month-end figure for September 2010 was even lower, at Rs6.57 lakh crore.
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Meanwhile, equity MFs saw net redemptions of about Rs21,700+ crore from August 1, 2009 to September, 2010. In fact, in September alone, the folios dropped by 5.8 lakh.

All this in a period when the Sensex rose about 30%! The market has made a new peak, but mutual fund AUMs are down.

In any industry, for the product/ service to reach the end-user, there is a distribution system. There will be a cost attached to this distribution system, which needs to be commensurate with the value it delivers. The current distribution system is efficient and cost-effective as MFs do not have agents on their payrolls and pay them only for services rendered.

A distribution system will have its flaws. The mutual fund distribution has its —- pushing new fund offers (NFOs), undue churning of clients’ portfolios, etc.

These problems needed to be addressed and the perpetrators needed to be disciplined.

Sebi could have addressed the problems by putting a cap on how much can be given out as a distribution fee for NFOs, as also, approve meaningful NFOs only. Also, it could have put in place a metric, which measures the churn in a distributor’s portfolio and affords him lower fee for higher churn.

Doing away with the entry load and asking distributors to collect fees directly from the clients was unwarranted brinkmanship. It simply undid a distribution system that was built over the years.

Here is the full charge-sheet against the capital markets regulator:

Making business unviable

Asking distributors to collect fee directly from investors is one thing and actually collecting it from them is quite another, as distributors have found. Somewhat ironically, most investors expect the distributor to pay them for investing. The upshot? Most distributors have moved away from MFs and the AUMs are falling. We keep hearing justifications every month for falling assets such as advance tax, profit booking, etc. But the major reason is that the distribution system is a depleted force and is in disarray.

Destroying distribution

That distribution is an integral part and a vital link in the entire industry seems to have escaped Sebi. The regulator’s other moves betray this too. For instance, charging the same exit loads for retail and institutional investors does not make any business sense —- the cost of acquisition and servicing are different. Retail investors would be subsidised by institutional investors, which is an unhealthy development.

Another example —- assuming that all distributors are able to collect a fee for services rendered, the costs of billing, collecting the fee, accounting and compliance have ballooned so much that the fee charged will go up, not come down as intended.

As a corollary, distributors are unable to service small-ticket requests as the costs of servicing them is high, making such deals unviable. Hence, the real small investors are left to fend for themselves.

Justifying wrongs
It might be very nice of Sebi to say that investors have saved `1,300 crore (2% of the `65,000 crore inflows in 2009). But that calculation is wrong.
The 2% metric used was the fee for equity funds, not all funds. Secondly, it exposes a deeper malaise —- if Sebi seriously thought distributors would be able to collect fees from investors, the savings would not have happened —- investors would only have paid distributors directly, rather than via the fund house.

If Sebi knew distributors would not be able to collect any fees from investors, then the move shows the regulator’s moral bankruptcy, wherein it willfully misled distributors, fully knowing that they will not be able to collect any fees for services rendered.

The other statement —- about profits of mutual funds going up —- is again a convenient ploy to deflect criticism, for it does not address the flight of money from MFs, which will ultimately cripple the fund houses.

Unsettling legislations

There has been a continuous stream of legislation aimed at MFs and their distributors. This has not allowed the industry to find its equilibrium.

Some of the legislation does not even make sense —- such as not disclosing the indicative returns/ portfolios in fixed maturity plans (FMPs).

How would an investor invest without knowing what he might be getting from his investments and where it will be invested? It would have been more appropriate to make the funds comply with some broad parameters.
What has now happened is that informal information and guesswork has supplanted proper, direct communication.

Compliance requirements (and costs) have also gone up. Compulsory PAN and Know Your Customer compliance will ensure that mutual fund penetration will not go beyond a small sliver of the population. No wonder the number of unique investors in mutual funds number about 80 lakh, against India’s population of 110 crore.

Siding with stock brokers
There is a push to dematerialise (demat) all MF units and probably move everything to the online platform. It is common knowledge that MF schemes just issue statements and there is no certificate involved. Apart from probably viewing the holdings on a screen, demat serves no useful purpose. It also entails a cost to the investor in terms of maintaining holdings in demat form.
Sebi seems intent on pushing all investors to use the online stock-broking platform. Both the National Stock Exchange and the Bombay Stock Exchange have MF platforms, but both have been non-starters.

Also, stock brokers charge on both the buy and sell transaction. One does not understand how this is in investors’ interest. Also the brokers thrive on churning, and thus want clients who do day-trading. It is unfortunate that Sebi wants investors in mutual funds to go to stock brokers, fully knowing this.

There is no alternative low-cost online platform exclusively for MFs. This means that all MF distributors will have to become stock brokers or sub-brokers to invest a client’s money in MFs. Stock brokers will get a percentage share of all business without doing anything. It’s ironical that Sebi wants distributors to charge on buy/ sell transactions now and share the fee with stock brokers.

Anti-distributor moves
It is clear that Sebi has a pathological aversion to MF distributors. Know Your Distributor norms have been introduced now for MF distributors, which involves bionic identification. How will bionic identification help when the details of MF distributors, including their PAN, address, bank account details, etc, are already there? Distributors have been regularly harassed and their commissions withheld for documentation/ non-compliance reasons. Is it a surprise then that AUMs are falling?

By demonising only MF distributors, Sebi is causing major harm to investors. For investors, investments through MFs remain the best bet to participate in the stock market. It is wishful thinking that all investors will invest directly and no handholding is required.

The New Pension Scheme has turned out to be a non-starter because there is no one to promote it. That’s causing the pension funds regulator — the PFRDA — to rethink the involvement of distributors. Now, it is Sebi’s turn to wake up.

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