Sebi changes rules, MFs innovate

INVESTOR FRIENDLY: New regulations will get better deals for the retail customers

Finally, asset management companies (AMCs) have had to give up on their ‘cosy’ (read:lazy) way of making money, thanks to the Securities and Exchange Board of India (Sebi) decision abolishing entry loads which by implication means that mutual funds (MFs) will now have to work towards profitability as a natural progression. 

Simply put, all that the market regulator did was to bring the focus back on the ‘investor’ which created an upheaval initially in the mutual fund industry. Yet, Sebi is not opposed to MFs and distributors having a mutually acceptable commercial arrangement to take their business forward, all they want is every thing should be transparent and comprehensible for investor to take an informed decision.

Agreed, the Sebi move may do lot of good in the long run but for now — in the short run or immediate outlook — MFs especially those with low assets have seen their valuations nosedive. From distribution perspective, equity funds have no takers now and independent financial advisors (IFAs) have begun focusing on other financial products including Ulips, general insurance and NSC to mention a few.

“Contribution of fixed income products in our product mix has gone up from 10 to 20 per cent in August 2009,” says Bajaj Capital Vice-Chairman & MD Rajiv Deep Bajaj.  Industry observers also say that contribution from MFs, which was 20 per cent in 2008-09, slipped to about 10 per cent since the regulation was introduced on August 1, 2009.

So much so, there could be more players looking to exit from the scene but for the valuation factor, aver experts. Those who want to continue are also in a dilemma as they need to pay distributors an upfront fees plus a higher trail commission to ensure fresh inflows and compete with big guns like HDFC, Reliance etc.  And this extra cost will dent their already-strained balance sheets further.  Said ICRA Online Executive Director Sanjoy Banerjee, “The industry’s profitability was already poor in 2007-08 and it could get worse now,” .

The impact
 The data released by the Association of the Mutual Fund Industry (AMFI), the total industry AAUM (average assets under management) for September 2009 stands at Rs 742,919 crore against Rs 749,915 crore in August 2009, showing a slide of 1 per cent in one month and is the second instance of a month-on-month decline in mutual fund assets in 2009 so far, the earlier one was in March 2009.

While most big funds witnessed declines, it is the smaller fund houses that have shown a healthy rise in their asset figures for September 2009 such as Taurus, Shinsei and JP Morgan reporting 25 per cent increase in their AAUM positions.

Ideally, revival in the equity market should have boosted the assets managed by mutual fund houses.  But call it a Sebi effect or whatever, equity schemes have failed to register any significant growth despite rise in the equity markets and improvement in valuations of the existing schemes.  “Distributors are just not interested in selling mutual fund products any more due to inadequate commissions,” say fund house officials.

In macro perspective, the Indian mutual fund industry has assets under management of Rs 6.7 trillion and 87,000 registered agents sell mutual funds in India. Roughly, these agents had earned about Rs 75 crore in the last fiscal (2008-09) as entry load fees and in the previous year — exceptionally good for equity inflows — saw them earning four times this amount.  It is this money that Sebi has targeted by tweaking the entry load regulations.

Further, in a bid to tightening the rules for exit loads, which are 1-5  per cent of the AUM, used to fund marketing expenses — a part of which is distributor commissions — Sebi  now says that only up to 1 per cent of exit fees can be used for marketing expenses.
As such, the pie is becoming smaller and distributors may ask for more trail commissions.  Market practice envisages fund houses to pay distributors trail commission at the end of every year to ensure higher churn of clients.

Prior to Sebi  tweaking norms, the cost of garnering new clients was borne by investors in the form of 2.25 per cent entry load on equity funds and as a result, fund houses were able to retain the 90 basis points to 1 per cent annual fund management fees in an equity scheme.  This income is now under severe pressure as the upfront payment of 50 to 75 basis points to distributors will have to be paid out of this.

Investors benefit
All these augurs well for the investors who largely believe that the Sebi  move empowers them in deciding the commission to be paid to distributors for the level of service they receive and also ensure parity among all classes of unit holders in terms of charging exit load. Says Quantum Mutual Fund President Ajit Dayal, :”It is great that investors are empowered to decide how much should distributors get and how much money should finally be invested.”

However, Dayal points out that it will have to first grapple with the excess baggage of 15 years of complete nonsense in the MF industry right from products mis-selling to products that should have never been in the MF space thereby hurting investors, explains he adding: “So there is complete relearning that needs to happen.”

Pratip Kar of the IFC’s Global Corporate Governance Forum and the World Bank avers that Sebi has given the mutual funds an opportunity for a game change.  The strategy would be to use this opportunity by breaking the existing markets and creating new ones, says he. 

Of course, nobody is disputing the transparency of the Sebi move which gives mutual funds a chance to relook their model to catch the fancy of retail investors in a big way.  Of course, there is concern over the process of transition and is not going to be easy.  HSBC India Mutual Fund CEO Vikramaaditya, says:“We should account for a long-term approach and how to manage that in the short run.  Implementing this is a challenge.”
 
Two options
The moot question is how much financial literacy exists now and to what extent investors will be in a position to take a rational decision on the services they receive from a distributor.  “This is a phase of recalibrating, readjusting and understanding as well,” says Association for Mutual Funds in India (AMFI) Chairman  A P Kurian.  The serious players or in the institutional distribution category like banks are probably working on two models.

One is ‘pricing’ the advice transparently.  “It is like: You want my advice, which fund or which scheme or which sector to invest, I have a price and a chart for it.”  Second is what you call it a ‘service’. For instance, fill the form, put it in a bank, which entails a transaction fee and has to be priced lower. 

Kurian envisages that the high-end of the IFAs are moving into the advisory model, while the low-end could try to do it in transaction business.  However, he feels that the stage of making the investor pay separately for service could have been done at a later stage. All the same, financial literacy is still at a nascent stage in India simply because majority of investors still depend on their advisors.  As such, it is a big challenge for fund houses and distributors in terms of convincing investors especially at the lower end of the spectrum as they may not understand the value of a financial advisor and also more accustomed to looking out for discounts and hard-bargaining rather than recognising a product’s intrinsic value.  Dayal of Quantum MF says: “There is a huge effort required here in terms of educating investors to a higher level.”

Indeed, there are advisory-based online platforms in the industry that can help in decision-making from investor’s end but then investor will have to decide what he needs to pay the agent but also choose the type of service his financial planner would offer, based on his fee structure.

Yet, there are operational concerns.  For instance, if a person is investing say Rs 10,000 and assuming there is a 2 per cent commission, then investors should get used to paying separate cheque for this Rs 200 fee for which there has to be an effective collection mechanism.  In markets abroad, there is a mandate to spell out the amount of fees the investor wants to pay the agent on the form itself. In the above context, Dayal points out that it is not unknown for people to make two separate payments.  Just the mindset in the industry needs to change, says he and cites an example of how patients in the hospital pays one bill for doctor’s diagnosis and another for an X-ray or medicines to the chemist.

Operational concerns over a period could get sorted with a bit of innovation thrown in by distributors who can offer a menu of services, which could include just a pick up cheque service. Currently, distributors are not regulated in India and it is desirable to have a body of financial advisors.   This suggests a huge potential for mutual funds to tap and to do this, they must first understand why investors are comfortable with fixed deposits, post office savings, NSC, LIC, gold & silver and properties in smaller cities and rural areas as compared to mutual funds. Then they should put in best efforts to tap these markets by integrating innovation into the mainstream of their business strategy, while manage risks and create new markets.