The work of a good regulator is never over. The new Securities and Exchange Board of India (Sebi) nudge to funds to declutter their product menus is the next step in the long walk to get mutual funds to think about investors and not their own profits or the distributors.
That there are schemes in the portfolio of fund houses that are almost mirror images of each other is a legacy of the past when fund houses found launching new funds a good way to gather investor funds. A skewed commission structure meant that a new fund offer could actually hit the investors with the cost of advertising, marketing and distribution, as 6% of the money collected through a new fund offer (NFO) could be amortized over five years and charged to the scheme.
The history of NFOs shows how fund houses focused on NFO launches to gather money rather than display any product innovation.
There are two problems with having similar schemes. One, it freezes a do-it-yourself investor. It is now well documented that when confronted by too much choice, consumers prefer to postpone the purchase decision rather than make a suboptimal choice. Two, those who are brave enough to buy run the risk of having too many similar schemes in the portfolio if they simply go by the name of the scheme.
Diversification of a retail portfolio has twin goals of spreading risk over types of schemes—choosing between a core of large cap or index, with a complement of mid-cap and sector—and across fund houses to counter fund-manager risk. Having 25 large-cap schemes, with five such schemes from the same fund house with the same manager, just replicates the index.
Managed funds cost more each year to the investor. If a Nifty exchange-traded fund (ETF) has an annual management fee of 50 basis points, a managed equity fund averages 2%, calling into question the logic of replicating the index through funds when a cheaper index fund would have worked.
Sebi’s nudge is in the right direction, but the funds will need to follow it in spirit and think about the investor when pulling out the blender. They need to look at fund houses which resisted the NFO greed and are at the top of the investor buy list today.
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