Sebi’s move to curb distributors may hurt MF investors
A person with surplus money is likely to invest it in four broad classes of assets and investments: Real estate, gold, fixed deposits and other investments.
The last decade has been brutal to nearly all investors. Gold hasn’t performed well except in spurts, real estate has been disappointing.
Ulips and other toxic products which were hard-sold with up to 45% commission would take a decade just to reach the par value. Fixed deposits provided an optical illusion, with high inflation, they mainly yielded negative real returns.
The only real investment which has consistently delivered, over any 3-year or longer period after all expenses, has been equity mutual funds.
An investor is free to invest directly in the stock market, or free to pay a fee to a mutual fund for managing his money. Similarly, an investor is free to directly invest in a mutual fund or invest through a distributor.
Market regulator Sebi provides a cap on the total fees chargeable by mutual funds to the investor. This has prevented creation and sale of toxic mutual funds.
Sebi’s circular effective October mandates disclosure of absolute amounts, instead of percentage, of commissions paid by funds to distributors. It also obligates the disclosure of the expense ratio of the fund where a distributor is involved and where it is a direct sale. These appear at flush blush to improve transparency, but will push investors away from mutual fund investments.
Firstly, the disclosure of commission in absolute number for investments is likely to overstate the commission in later years.
For a distributor, investment advice, fulfilling suitability, KYC norms, cost of travelling and selling to the investor and other costs are incurred in the first year and the benefits are usually paid by way of trail commissions over many years.
Sebi has encouraged this underpayment initially with emphasis on the ‘trail’ as being useful for the cause of longterm investment. Clearly, the investor will be unhappy seeing a commission paid in year 5 when little service is provided.
Secondly, showing the expense of a direct plan versus showing the expense of a distributed plan every six months will goad the investor into believing the two products are identical and he is wasting money on the distributed plan. A distributor is no longer merely an agent of the fund as Sebi has imposed specific KYC and suitability norms on the distributor.
Thus pushing an investor away from the distributor is likely to push the investor away from the most suitable products. The average small retail investor in the absence of proper advice may buy overrisky products because they seem to produce better returns or buy under-risky product resulting in low income.
Of course, a sophisticated investor does not need a distributor, but the number of sophisticated retail investors is quite limited. Sebi has already made sufficient disclosures mandatory showing the different expense ratios between direct and distributed plans.
Thirdly, many costs are attached with creating a mutual fund product including asset management fees, trustee fees, registrar and transfer agent fees, legal and audit fees, advertisement and Sebi fees. It is unclear why only one of them is deemed important from a disclosure perspective, except to push a dis-intermediated model.
Finally, the real danger of a disintermediated model is this. Only 11% of equity funds are sold directly, the balance nearly 90% is sold through distributors. These distributors travel through smaller cities, or spread the message through bank branches and are spreading the word of the relatively safe, high-return investment with a small and capped expense ratio.
If these distributors are dis-intermediated, what will happen will be not sale of lower cost mutual funds as Sebi is aiming. But rather investors will move away to other push products like Ulips, which are toxic, fixed deposits, which post inflation reduce wealth, or non-productive assets like land and gold.
If India wants to build its equity markets, build its infrastructure, build a productive industry which requires capital, it must seek full disclosure and cap on fees as Sebi has rightly done till now, but it should not physically seek to dis-intermediate distributors. That will hurt most the investors, the regulator seeks to protect.
Economic Times New Delhi,23th August 2016