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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 market regulator Securities and Exchange Board of India (SEBI) comes into effect. SEBI has instructed that mutual funds cannot levy any entry charges for investments but allowed distributors to claim a fee for their advice from investors. It also directed them to disclose commissions 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 and distribution costs. The charging of entry load resulted in less of investor’s money being invested in an MF scheme. For example : If you invest Rs. 5,000 every month in a MF scheme; and if there is an entry load 2%, Rs. 100 would be deducted upfront from your investment. That is, instead of the full Rs.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 longterm inflows as distributors adjust their business models to generate more volume and trail fees (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 funds industry 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 funds industry.” 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 houses have already started to promise an upfront commission of 2% to the distributors. Sabapathy Iyer, CEO of JR Laddha Financial, a distribution house, in Mumbai said, “How long are the fund 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 investors will 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 the investor. Now he will have to continue to be in touch with the investor, providing real services, 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 will change the intermediation that existed earlier, because of the revenue pool that fund managers and distributors work on and which they share between themselves will be reduced from August 1 onwards.” "It will discourage unnecessary NFOs (new fund offers) because what was happening is a distributor who was earning 2.5 percent commission was interested in churning people from one 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 the end 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 now have 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 fund houses 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 ability to gather assets in new funds by paying large upfront commissions out of entry fee, it make investing 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) mutual fund market, because distributors will have less of an incentive to promote new products offered 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 from insurance and pension funds, since distributors are likely to market more products similar to mutual 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 revamp their 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 1 onwards could be compensated for by a strong market performance and more active mutual fund investors. “Most investors believe the rule change is a good move; it will make investors a bit more proactive
IMPACT ON EMPLOYMENT OPPORTUNITY
The asset management industry does not invest directly in building a large sales force to market 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. The awareness of funds is not very high, and the average retail client is not very comfortable deciding from the vast array of choices. Currently there are only 75,000 AMFI certified agents in the country which is very low for a country India’s size. That entails a lot of education and investment; the low margins of the industry are not allowing it to make that investment. This scenario gives a wide range of employment opportunity as Asset Management Companies (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 to market and sell funds as there is no margin for them. There are various distributors in the market 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 as against 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 penetration level of the Distributors.
The fixed entry load structure followed earlier, had an embedded conflict of interest for distributors. As distributors made a fixed sum on mutual funds notwithstanding their performance, they had an incentive to push MF schemes, even if the investor did not require it. This led to constant churning across schemes and hindered long-term asset creation. Therefore, it is appropriate that SEBI is putting an end to this practice. In the new scheme of things, the investor will pay a fee to distributors and has the option to negotiate it based on the quality of the service provided. In a nutshell, the new regulation will lead to long-term asset creation. However, there is no clarity on whether investors or AMCs will be paying commission to distributors. A majority of retail investors do not have the tools to find appropriate information about financial products. Therefore, it seems that they are not on an equal footing with distributors. The latest move might complicate matters, as it expects the investor to negotiate with distributors on their own. Investors should be really cautious, especially if the distributor seems overeager to sell ULIP products. To conclude, Paul Samuelson, winner of the Nobel Prize in Economics rightly said : “A small man – anyone with a portfolio of, say, under $100,000 – is unlikely to do as well investing his own money as he can do in a no-load fund.”
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