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Impact of Cap on Entry Load for Mutual Funds

Impact of Cap on Entry Load for Mutual Funds

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Published by: Radha_mba(finance)_MSRIM on Nov 01, 2009
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02/28/2011

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IMPACT OF ENTRY LOAD BAN IN MUTUAL FUNDS
Background
The Indian Mutual Fund (MF) industry has witnessed one of its major transformations from
August 1
, as the ban on entry load investments in all MF schemes imposed by the marketregulator 
Securities and Exchange Board of India (SEBI)
comes into effect. SEBI hasinstructed that mutual funds cannot levy any entry charges for investments but alloweddistributors to claim a fee for their advice from investors. It also directed them to disclosecommissions earned to clients.
Concept of Entry Load
“ Entry Load ” is an upfront charge levied by fund houses when you invest in various MF  schemes. This load used to vary from 0% to 2.5%.
This load was charged (supposedly) to compensate the MF houses for marketing anddistribution costs. The charging of entry load resulted in less of investor’s money beinginvested in an MF scheme.
For example :
If you invest Rs. 5,000 every month in a MF scheme; and if there is an entryload 2%, Rs. 100 would be deducted upfront from your investment. That is, instead of the fullRs.5,000, only Rs. 4,900 is actually invested in the fund.
IMPACT OF ENTRY LOAD BAN
SEBI’s move to ban entry fees for investments into mutual funds will lead to a jump in long-term inflows as distributors adjust their business models to generate more volume and trailfees (recurring fee paid to the distributor).
Positive result of this move
According to analysts, “This is one of the most significant changes that the mutual fundsindustry has seen in recent times. It is a positive move for the benefit of the investor community, for the benefit of regulation and for the transparency of the mutual fundsindustry.”It would reap a host of benefits to the investors such as :
 Higher returns for the same investment 
 
 Lesser advice to churn your portfolio
 Improvement in quality of service due to fee-based advisory services
 Lesser New Fund Offers (NFOs)
 
 
Change in the attitude of investors
 
IMPACT ON DISTRIBUTORS
The ban on entry loads – the
2.25-2.5 per cent
fee mutual funds charge investors on schemes,which is used by money managers to pay distribution commissions – is seen by insiders as a paradigm-shift reform for the Indian market.This move by SEBI will have major impact on distributors and the
 Independent Financial  Advisors (IFAs)
, as their margins are likely to take a major blow. But several fund houseshave already started to promise an upfront commission of 2% to the distributors. SabapathyIyer, CEO of JR Laddha Financial, a distribution house, in Mumbai said, “How long are thefund houses going to pay the upfront commission? In the long run, only those who provide better service to the investor and have maintained a cordial relationship with their investorswill survive.”The ban is expected to have a big impact on the way distributors take care of their clients.“What has been happening until now is that once a distributor sold a fund he forgot about theinvestor. Now he will have to continue to be in touch with the investor, providing realservices, so that the investor feels obliged to pay the distributor.”“Clearly there will be a
reduction in business
and
activity will slow down
. The ban willchange the intermediation that existed earlier, because of the revenue pool that fund managersand distributors work on and which they share between themselves will be reduced fromAugust 1 onwards.”"It will
discourage unnecessary NFOs (new fund offers)
because what was happening is adistributor who was earning 2.5 percent commission was interested in churning people fromone scheme to the other just to make sure he makes his commission,"As per data compiled by the
 Association of Mutual Funds in India (AMFI)
, ‘More than half of the
1.2 trillion rupees
equity assets of the funds industry was less than two years old at theend of March, 2009’ as a result of frequent
churning 
. This is set to change now as distributors,who get an upfront fee from about 2.5 percent entry load that equity funds charge will nowhave
no interest in making investors switch funds.
 Instead, they stand to gain more in the form of 
trail fees
or the money they get from fundhouses on continuous basis, if investors kept the money invested longer.
 Distributors will evolve an advisory fee model and will also get remuneration from fund houses for distributing products either in terms of upfront or increased trail 
,”While the changes will hurt distributors revenues in the short-term and limit fund firms abilityto gather assets in new funds by paying large upfront commissions out of entry fee, it makeinvesting cheaper and more transparent for investors. A distributor 
"would be more interested to keep his trail alive,"
Abizer Diwanji, head of financial services at consultant KPMG said.The ban is also likely to have a negative impact on India’s
$137bn (€96.4bn, £86.2bn)
mutualfund market, because distributors will have less of an incentive to promote new productsoffered by the mutual funds.
 
“In the short term there will be disruption to business, as distributors will try to find other  products that reward them better,” 
 Fund managers also fear that, in the short term, they may face
 growing competition frominsurance and pension funds
, since distributors are likely to market more products similar tomutual funds that have not been hit by the entry load ban.However, over the medium to long term, fund houses and distributors are expected to revamptheir business models and will look for new pay-out structures, according to Sukumar Rajah,chief information officer at Franklin Templeton India.Mr Kumar of IDFC believes that the short-term fall in product launches from August 1onwards could be compensated for by a
 strong market performance
and more active mutualfund investors. “Most investors believe the rule change is a good move; it will make investorsa bit more proactive
IMPACT ON EMPLOYMENT OPPORTUNITY
The asset management industry does not invest directly in building a large sales force tomarket and sell its funds to investors. Third party distributors are very important.Mutual Fund companies will continue to focus on selling products through its distribution partners as they find it difficult to envisage funds taking their products directly to clients. Theawareness of funds is not very high, and the average retail client is not very comfortabledeciding from the vast array of choices.Currently there are only 75,000 AMFI certified agents in the country which is very low for acountry India’s size. That entails a lot of education and investment; the low margins of theindustry are not allowing it to make that investment.This scenario gives a wide range of employment opportunity as Asset ManagementCompanies (AMCs) would now look to employ people directly for marketing and selling their Mutual Funds to the investors.On the other hand, it is also likely that Distributors would now employ less sales force tomarket and sell funds as there is no margin for them. There are various distributors in themarket who employed such people, who might have to bear the brunt of this entry load waiver.AMCs might plan to deploy its own task force but they would mostly be
highly-skilled 
asagainst Distributors who employed
lower-skilled 
force with the capability to just “market” and“sell”. However, AMCs would not be able to match up with the competency and penetrationlevel of the Distributors.

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