Sometimes a committee leaks a proposal it is considering to test reaction in stories and comments. Or sometimes it is a dissenter to what is being discussed who will leak a proposal or a decision to get public opinion against what is being proposed. Either of the two must have happened last week when we read that a Securities and Exchange Board of India (Sebi) committee examining a new compensation structure for mutual fund distributors is close to recommending a Rs 100 transaction fee on the sale of a mutual fund product. The quick push back from both distributors and consumer activists shows that both are unhappy. The distributors say that a flat fee of Rs 100 does not even cover the cost of transport and is neither here nor there. The consumer voices say that a flat fee is inherently unfair, translating to a 10% cost for a Rs 1,000 investor and a 0.1% cost for a Rs 1 lakh investor. They fear that this fee is an attempt to get entry loads in through the back door. It may begin as Rs 100 today, but what will prevent it from becoming Rs 1,000 tomorrow? Or coming back to a percentage in another year’s time?
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Clearly a flat fee is not the answer to the question of distributor compensation. And a one-cheque system that collapses the fee and the investment, too, is akin to going back to the entry load system. I think the question till now has been framed erroneously with different people looking at it from different points of view. Could framing the question differently throw up a clearer answer? Let’s frame the problem like this: the distributors of financial products must be compensated because they provide a key service that links product manufacturers with consumers. The compensation should be such that it encourages them to look after the financial health of the consumer. If we agree that this is a good question to seek an answer to, what then is such a model?
There are three ways that charges can be efficiently levied on a financial product—at the time an investor enters the fund as a percentage of the amount invested; at exit, as a percentage of the amount being taken out; on an on-going basis as a percentage of the money left with the money manager, in this case, a mutual fund. A more sophisticated version would look at performance-linked payouts from the consumer to the producer, but I think we are still battling basics right now and to bring that in would confuse the issue even further, so we stick to the first three. The first, an entry load, has been tried and we know it leads to sharp sales practices and to investors getting churned. The exit-load unlinked to the tenor of the investment will do exactly the same—encourage churning. The only option left is for a model that pays out of on-going cost or the annual expense ratio.
This is the model that has been in operation for almost two years now and it is worth seeing if the shock of a no-load world has been absorbed. The committee needs to look at what the numbers are showing. Net inflows into equity funds are positive for the month gone by, that is, May, at Rs 1,546 crore; for the year gone by—May 2010 to 2011—at Rs 470 crore; and for the year before that—May 2009 to May 2010—at Rs 123 crore. So, net positive inflows into pure equity funds are back. It needs to see that nearly Rs 5,700 was collected by existing schemes and just Rs 137 crore by one new fund offer in May 2011 in sharp contrast with May 2005 when Rs 4,000 crore was collected from new fund offers (that carried an effective load of 8%) and less than half that from existing schemes. The committee needs to consider the fact that the worst of the outflows, at a net of Rs 7,000 crore in September 2010, were less than 4% of the total assets under management (AUM) of equity funds with the mutual fund industry at that point. It needs to consider that equity SIPs (systematic investment plans), that are the smart way for retail investors to average cost and use monthly surpluses, are strong and increasing. Clearly the no-load world is settling. The biggest lobbyists for loads, the banks and the large national distributors, are noisy and unwilling to look at a reworking of their business model using technology— much easier to try and lobby the load back. It would be a great pity to tinker with a system that is slowly working the froth out and stabilizing into a structure that is built on a strong foundation. And is fair to all.
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