Mumbai: The Rs7.2 trillion Indian mutual fund industry is revisiting its business model to be in sync with the new norms put in place by the capital market regulator, the Securities and Exchange Board of India, or Sebi.
India has 36 asset management companies (AMCs) and at least some of them are planning to start their own distribution business instead of selling funds through third-party distributors. Among other things, they plan to cut distributors’ commission by 25-30 basis points (bps) and shift their focus from frequent churning of funds to managing money for the longer term. One basis point is one-hundredth of a percentage point.
Sebi banned fund houses from charging investors an upfront fee of up to 2.25%, known as entry load, from 1 August. That encouraged fund houses to fine-tune the exit load, or the penalty they charge investors on premature redemptions, from six months to three years. In other words, fund houses have forced the investor to lock in their investment for three years if they do not want to pay the exit load.
Time for fine-tuning: The Sebi headquarters in Mumbai. The market regulator banned fund houses from charging investors an upfront fee of up to 2.25%, known as entry load, from 1 August. Abhijit Bhatlekar / Mint
The exit load is currently capped at 1% of investment. However, only retail investors are subjected to this and fund houses do not charge the exit load on any investment of Rs5 crore and above.
The plan was to use the exit load to take care of the commission paid to the distributors. The fund houses also announced a new incentive structure for distributors ranging between 0.5% and 1.25%. JM financial Asset Management Pvt. Ltd is offering 1.25%, UTI Asset Management Ltd 1% and HDFC Asset Management Ltd 70 bps, one of the lowest in the industry.
However, this move has not gone down well with the market regulator. It has directed fund houses to bring parity in the exit load for all class of investors, irrespective of the amount of investment.
It also said fund houses should follow a uniform exit load structure for all plans within a scheme. Normally each mutual fund scheme has different plans catering to different classes of investors.
Finally, on Tuesday, Sebi asked the fund houses to limit the lock-in period to one year. The three-year lock-in, planned by AMCs, would have covered a major portion of equity fund investments in the industry.
According to the industry lobby Association of Mutual Funds in India (Amfi), 57.23% of all the equity investments as of 31 March were less than two years old. The rest of the corpus was more than two years old, but Amfi does not specify the maturity profile.
According to Rajesh Krishnamoorthy, managing director of iFast Financial India Pvt. Ltd, a transaction intermediary, “a minuscule portion of assets would be more than three years old”.
This means that had the lock-in period been kept at three years, almost the entire assets under management would have been subjected to the exit penalty. Only 20.33% of the equity assets managed by the industry were less than one-year-old on 31 March.
A majority of the sales in mutual funds come from third-party distributors. Some fund houses say the dependence on third-party distributors may decline gradually following the regulatory changes.
“The brokerage structure has to come down to adopt the new changes. The impact of the recent changes on distributors’ commission could be 25-30 basis points across the industry,” said Suresh Soni, chief investment officer at Deutsche Asset Management (India) Pvt. Ltd.
Waqar Naqvi, CEO, Taurus Asset Management Co. Ltd, said “Incentives for distributors will have to come down. Each AMC will take a call based on its subscription-redemption ratio. It varies between 35% and 50%. This means roughly between 35% and 50% of the subscriptions into mutual funds get redeemed within the first one year.” Subscription-redemption ratio is the proportion of investors withdrawing their investments. If the ratio is high, funds will pay a lower upfront commission.
Some fund houses say while reducing the incentives for distributors, a separate loyalty-based bonus programme could be started by the AMCs in order to encourage the distributors.
“The entire business model needs to be reworked to encourage the distributors, as their commissions are reduced by 25-30 bps. We may have to start loyalty-based bonus programmes for the distributors to encourage them to continue with fund distribution business and add more long-term investors to our customer base,” said the chief marketing officer at an AMC, controlled by a large bank, who didn’t want to be named.
As a part of the loyalty programme, a distributor will be paid a fixed commission every year as long as the investor stays invested in a scheme. This could happen as early as next month.
“One way out could be (to) progressively increase the trail commission earned by the distributors—the longer the investor remains the higher trail the agent gets,” said an executive whose fund house is currently offering a new fund.
The trail commission is paid to agents by fund houses at the end of the year based on the assets they helped bring in.
For instance, if the first year trail is 50 bps, it could be raised to 60 bps in the second year and 75 bps in the third.
“Although we cannot comment on specific changes that will be made in distributors’ commission, we believe that even if margins fall, the volume is poised to increase as mutual fund loads have been relaxed for investors. We believe that margins will be compensated by volumes,” said Sundeep Sikka, CEO, Reliance Capital Asset Management Ltd, which manages at least Rs1.08 trillion in assets.
“The trail commission is essential if the distributors need to be encouraged to sell. But if there is no penalty on exit, it makes more sense for the distributor to encourage the investor to sell the units and enter a new scheme,” said Sanjay Sinha, CEO, DBS Chola Asset Management Ltd.
Others agree. “If something becomes cheaper the demand goes up,” Soni of Deutsche Asset Management said. According to him, fund houses will revise their business model and work more on volumes rather than on margins.
“Some fund houses may shift their focus from third-party distribution channel and start their own distribution services and strengthen their physical and Internet banking channels,” he added.
As of June, there were 91,671 agent distributors registered with Amfi. Most banks and 20-25 large national and regional distributors also sell MFs.