I am told that this stance to do away with upfront commissions paid to distributors of Mutual fund Schemes has a deep rooted 'welfare' objective for the average 'retail investor'. Noble thought – only that given the current 'distribution system' of financial products in India, attacking upfront commissions on MF sales (in isolation) seems like building a barbed fence around your house when mosquitoes can take your life.
To clarify something basic -- Mutual Funds are an unique vehicle of investment, in that they accept applications from retail and large (individual) clients alike. A Rs. 25000 and another Rs. 25,00,000 are treated the same if they come as single cheques; they will be invested into the same investment scheme, pay the same asset management fees (charged to the NAV) and as a percentage point, earn the same commission for the distributor. Most set-ups 'distribute' Mutual funds for this commission instead of charging a fee to the client. That is just how it is in India.
People do not want to pay fees. Also, this may be a good time to highlight that the Government levies a 'service tax' of 14% on this commission earned. This is, by the way, grudgingly paid by distributors again. When you eat at a restaurant, as a customer, you pay a service tax to the Government and a service charge to the restaurant. However, when you are serviced by an educated employee of a set-up that offers you the benefit of choosing the funds, doing the paper work, providing a consolidated statement and updating you from time to time, you do not want to take the 'brunt' of a service tax or fees and now do not wish that commission be paid to your distributor also! Try saying you won't pay all those extras at the restaurants and be prepared to be booted out. Get the drift?
Now let us examine who is this 'Retail Investor', this tormented soul, the much cared for creature today, who is being 'fleeced' because his Mutual Fund distributor is making less than 1% upfront commission on his investments? Then we can discuss if it will be worthwhile to support his/her cause.
Let me tell you a story -
My friend, who worked in Singapore for a Multinational Consumer Brand, has come back to India recently. Her first and only experience of buying a financial product happens to be her bank's relationship manager recommending her to buy a 'whole life insurance plan' (I have written about these before, they pay the highest brokerages) when she asked for advice to build a 'pension portfolio'. After a long standing battle (with the insurance company), she just got back the premiums she paid. Naturally wary, she wrote in to me the other day for some help – my opinion on an investment plan recommended to her by a trusted source. She has 30 lacs to invest and I am branding her as a retail client here. She may be open to paying a fee for the advice but that has not been explored yet.
The recommended portfolio had some 'asset allocation': Debt and Equity. In Debt there were income funds and gilt funds. In Equities, there were a few midcap funds and that is about it. I disapproved (naturally). She says she wants to spend time with me before investing. Now here is a post graduate, once internationally employed woman in her late thirties, in dire need of advice, unable to distinguish between what an income, gilt and a liquid fund is. She is not clear why a debt fund could ever show losses, let alone understand what interest rate/credit risk is. She wants me to give her a crash course which I assume will take days, and then some continuous advice.
Now, she is a school friend, I will spend that time with her and not charge her a fee. It is absurd that any RM/wealth manager unrelated to her would do it. Why? Because that person's employment depends on doing a basic number where trail fees do not matter. Trail fees make sense in a large private banking book that takes years to build, and did I tell you that RETAIL INVESTORS do not contribute to making this sizeable book. The numbers simply do not add up.
Now what do you think will happen to my poor friend if she approaches some distribution arm or an independent advisor in a situation where there is NO upfront fee? My bet is, she will no longer be offered mutual funds. Even with 30 lacs, she is not important to an average distributor to be advised correctly. In the event that she now may not be mis-sold an insurance policy to, and since she clearly doesn't have enough wealth to buy more sophisticated products offered to HNIs, I bet she will not be attended to at all. One may argue that an upfront commission will not ensure correct advice but please hear me when I say this, she will now get NO advice. THAT is what banning of upfront commissions in isolation will do.
The more unprofitable the MF business becomes, the lesser attention will be paid to it and even lesser research will happen around it. Meanwhile more and more 'opague' products will be launched (with the approval of the same regulator by the way), distributors will find a way to distribute them and run their shop. I am sorry, retail mutual fund investors will NOT benefit.
If regulators really want to change the way financial products are distributed in India, an all encompassing vigilance is required. Every product distributed needs to be scrutinised under the same lenses, and checks and balances need to be placed across all distributors. Distributor certifications should be made mandatory and investor education be taken seriously. That, I am afraid will require a lot of work. We understand that. But for heaven's sake, in the meanwhile, I would urge the regulators to not ban upfront MF commissions and imagine that they are being 'saviours' of retail investors.
P.S: I was not alarmed when upfront commissions were made uniform (to avoid rampant selling of new schemes etc) but banning them entirely is just a silly idea. I can't believe there is a nationwide debate on this! Whoever thinks that the degree of sophistication in MFs is so low that just about anyone can understand the nuances without guidance?
And before anyone pounces to comment about what happens internationally, let me point out that internationally, the model is that of 'advisory' and not 'distribution' and clients pay advisory fees. Nothing comes free my dear, why should Mutual Funds?
(The article was first published on the author's blog)
[Disclaimer: This article reflects the writer's personal opinion and does not necessarily represent the views of IBTimes India.]
