"We think we should leave it to market forces to drive the fees/charges that intermediaries levy on investors… We will continue to monitor the progress.” This was the reaction of the Securities and Exchange Board of India (SEBI) to a Moneylife query about the impact on retail investors of its decision to scrap entry load on mutual fund schemes from August 2009.
Two months later, the turmoil triggered by SEBI’s well-intentioned but ill-planned decision continues. Admittedly, mutual fund distributors who were creaming off as much as 6% in fees and incentives had to be reined in. The fund industry was also to blame for this situation. Its frequent policy changes hurt retail investors. For instance, UTI Mutual Fund (UTIMF) sold its Systematic Investment Plans (SIPs) in 2005-06 with a huge promotional campaign promising ‘no entry load’. Investors were persuaded to sign up for long tenure (10-15 years) SIPs on this promise. In November 2006, UTIMF suddenly changed the rules and announced a 2.25% entry load, even on existing investors, applicable from November 2008. It ignored allegations of ‘breach of trust’ and charged this load for eight months, until the SEBI order forced it to abandon the practice in August 2009.
So how are the market forces shaping the mutual fund distribution business? Mutual funds do not want to antagonise the regulator with loud protests. They have kept the show going by paying out a 0.5% commission to advisors from their own fees; the larger distributors are being paid 1%. Some, like JM Financial Asset Management which have a poor long-term performance record, are even paying as much as 1.5% as upfront load plus 1% brokerage on SIPs and STPs; such a steep payout will affect the profitability as well as long-term survival of the asset management company (AMC). In the circumstances, the fund industry is even more focused on large corporate investments and has no interest in incurring the high cost of servicing retail investors. Most fund managers are candid about this in private conversations.
But where does that leave retail investors who have no bargaining power but account for nearly 37% of the funds collected? SEBI believed that the industry will figure out a way to reach retail investors or to persuade them to pay for investment advice. But there is no evidence of this, as yet. Instead, there is a broad consensus that it is far too expensive to service retail customers without charging an entry load.
The 25,000-strong community of independent financial advisors (IFAs) is confused and there are conflicting reports about their reaction. A business newspaper reported that financial advisors in second- and third-tier cities have started charging consultancy fees or advisory fees to retail investors for every visit to their office. These apparently vary from Rs100 to Rs250 per visit with hefty additional charges for redemption and realignment of portfolios. This is rather hard to believe because most IFAs offer a menu of financial products (IPOs, insurance, insurance-linked equity products, non-convertible debentures and corporate fixed deposits) that still pay good commissions.
That is why many IFAs are smoothly persuading investors to move away from mutual funds. A Mumbai-based advisor says, “Investors are not at all open to the idea of paying any fee to advisors.” In fact, financial advisors “do not even dare to ask for fees, for fear of losing clients. They are simply waiting for better sense to prevail on the part of regulators,” he says. Large distributors, however, want to salvage what is apparently a Rs3,000-crore business by banding the advisors together to set up the Financial Intermediaries Association of India (FIAI) and give themselves a voice and a platform to engage with the regulator. The effort is led by heavyweights such as HDFC and ICICI Bank, BNP Paribas and Bajaj Capital, Karvy and Religare. This too is interesting because the recognition they crave is bound to be accompanied by regulation and increased responsibility.
Ironically, SEBI, under CB Bhave, felt that mutual fund regulations needed a fresh look. He was the first SEBI chairman to feel the need for a separate mutual fund advisory committee. However, the committee has only met twice since it was set up. SEBI has not bothered to consult it on a major decision like scrapping entry loads. Media reports suggest that SEBI is also planning to order mutual funds to segregate retail and institutional investment creating separate portfolios and independent net asset values (NAVs). This, too, if true, has not been put to the mutual fund advisory committee. Again, we have no issue over the logic of such a move. In October 2008, Moneylife had pointed out how the flight of corporate money from mutual funds, especially fixed maturity plans (FMPs), had caused losses or damaged the returns of retail investors who were slow to react to the financial crisis and the consequent steep decline in stock prices. SEBI seems to have taken a year to react to that situation.
Meanwhile, the heady days of 2007, when AMCs were valued at 5%-6% of the assets under management, are gone, despite the market recovery. In 2008, several AMCs suffered massive, probably irrecoverable, losses. The bottom 10 of these AMCs were in deep trouble. Only Lotus Mutual Fund and DBS Cholamandalam have been sold. One fund has sacked its CEO and 200-odd people and sought an audit of all accounts. Lotus created a low benchmark by selling out at cost, but L&T Finance’s acquisition of DBS Chola at a very reasonable price may be the first of more exits of the weak players. On the other hand, SEBI has around 20 applications pending to launch new schemes. Most of these are hoping that the booming market will ensure a steady flow of corporate money, at least for the tax benefits that mutual funds enjoy in the name of retail investors.