Are loads back? The distribution industry was agog when news filtered out last week that the Bajpai committee set up by the Pension Fund Regulatory and Development Authority (PFRDA) had recommended a 50 basis points (bps) charge on the National Pension System (NPS) point of sale. A quick backgrounder: The Bajpai committee was set up to find out why the low-cost NPS is not popular with the retirement corpus-targeting Indian. Less than 50,000 people have handed over about Rs 100 crore of funds to NPS in the two years it has been thrown open to the Indian public. In contrast, equity funds have gathered a net of Rs 470 crore of retail money in the past 12 months despite the absence of a load on the product.
NPS, found the committee, is not doing well due to several reasons, including lack of a government push to the scheme and lack of incentive to the entity selling the product. A single advertisement from PFRDA resulted in 4,000 consumer calls, documents the report, and a much stronger public awareness campaign would generate demand. But even the demand generated has not been adequately converted into consumers, the committee believes, due to lack of an efficient incentive to the point of sale. The current structure levies a flat charge of Rs 60 and then Rs 20 for each transaction. At the entry level, this puts a cost of 1% for the entry-level subscriber on Rs 6,000 annual subscription that falls to a minimum of 0.33% in subsequent years for one contribution, but is 1.33% for four contributions. The flat charge, says the committee, is unfair to the lower-ticket investor as costs drop dramatically with every Rs 1,000 of investment. Of course, this is a partial view of the product. If we add all the costs, including annual management fees, NPS is still the lowest-cost product in the market. But we’re looking at just the issue of transaction cost here.
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So, are loads back? No. Let’s differentiate between a load and a transaction cost. A load is the distribution cost embedded into the product that may or may not be disclosed to the consumer. A transaction charge is levied on the investment and is paid in addition to the amount invested; for instance, the broker charge for a stock buy or sell. From what I understand of the recommendation, the committee is not talking of embedding the 50 bps cost into the price of the product, but as a separate charge. This is no different than the mutual fund no-load rule, except that the committee has put a number to the cost of distribution that it thinks is fair.
Will this lead to churning? No. A distributor can churn the investor by encouraging him to switch between funds and earn the 0.5% charge several times a year. NPS has a no-cost fund switch option—the investor can request a switch between a badly performing fund to a better-performing one once a year. Nor can the distributor encourage the investor to redeem the entire corpus in NPS and reinvest (earning him 50 bps on the whole amount) into another product because NPS has a lock-in till age 60. Redemption before that is not allowed without a large amount getting converted into an annuity, effectively making it a product difficult to churn.
Will this sell NPS? The incentive is too little to get the distributor who wants the 2% load back interested—you’ll hear more of the “it does not even cover my cost of petrol” argument. Nor will it stop the nudge to the NPS-seeking investor to other higher transaction-cost carrying products. From the distributor’s point of view, the insurance product is still paying about 8-10% upfront commission and mutual funds are dipping into their expense ratios and capital to pay between 50 bps and 1%. The distributor will go on maximizing his income and a person asking for NPS will be sold an endowment insurance policy that is still carrying a hefty commission cost. The only way to effectively fix mis-selling, that the committee is equally worried about, is to get in a basic set of advisor regulations that will be the same for all products. At the minimum, they will establish the suitability of the product sold to the person who is buying. Then the varying incentive structures will not skew the seller nudge.
What this recommendation may do is to settle the question of what is the government view on a reasonable transaction cost. The retail financial products market has been waiting for some clarity on how to price this post the no-load world after 2009. What it may do is to establish the maximum transaction fee in the market at 50 basis points for retail financial product sales. Of course, portals and brokers with a large online presence can go on reducing this till they hit the bottom of Rs 20 per transaction. I would recommend removing this lower band and letting the market go to zero transaction cost.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and can be reached at firstname.lastname@example.org