There is a lot of anxiety about the future of mutual funds (MFs) as a retail investment option due to the elimination of upfront distributor commissions. Similar doubts (though at a lower decibel level) are being voiced on the future of unit-linked insurance plans (Ulips) after the recent regulatory changes that have drastically cut down commissions payable to distributors. Normally a cost cut should lead to an increase in the sale of the product since it becomes more attractive for consumers. Clearly, if this cut is causing more gloom than cheer, there is something more to it than what meets the eye.
There is almost a complete consensus that the number of individuals active in the financial services distribution industry will be hit significantly. Today around three million individuals are engaged in the business of distributing insurance and MF products across India. For most of them, the financial services distribution business is only a side business, while they go about making a living through another occupation. The number of such part-timers is difficult to estimate, but these are the first people who will go back to growing coconuts (or whatever else they are doing for a living anyway) as the margins in the financial product distribution business are not good enough to sustain their interest. Their exit is unlikely to be lamented for long as the people left behind will be those who depend on financial product distribution for a living and will be willing to make the adjustments necessary for long-term survival and prosperity.
Perhaps, the only time the mass customer thinks of investments is when he has to make tax-related investments at the end of any fiscal year. If this tax pull did not exist, the mass consumer may not think of investments at all. If he does, he would invest in traditional instruments that are easily understood and accessible. The issue is, therefore, that investments are required to be sold to consumers rather than being bought by them. Since it is easier to sell investments such as Public Provident Fund (PPF), National Savings Certificate, long-term bank deposits (which apart from tax pull have perceived safety advantages), they have much smaller distribution margins. But investment options that are relatively more complex require a harder sale push—insurance policies and MFs need a higher distribution margin to cover for the higher sales cost. These products will be unviable for the distributor without relatively higher margins.
Remember the time when the Securities and Exchange Board of India had a rule that “direct-to-fund-house” customers would not pay an entry load. Only a very small number of customers actually took advantage of the facility (perhaps the same small number that are ready for advisory services) and most retail inflows in MFs continued to be handled by the agents.
So why do distribution margins have to be upfront?
Most of the effort is put during the initial sale and hence needs to be paid upfront. Also, consumers are not disciplined in continuing with regular investments for long periods. For MFs, an individual folio in an equity-oriented scheme lasts for around three years.
In fact, if the consumer continues investing for the long term (say 15 years), then in the current scenario the agent is likely to make more money from selling him MFs rather than Ulips. This is because in an MF his commission (though a very small percentage) is calculated on the total value of the investments, rather than a percentage of the premium paid as in the case of Ulips. Over time as the value of the investment grows, the agent’s fee grows too.
Although the agents make more money from MFs rather than Ulips in the long term, he will still be reluctant to recommend MFs over Ulips as he is not confident that the investor will continue to invest in the plan for more than five years. The big difference is the upfront commission that the agents can make in Ulips. Till this vital (from the agent’s point of view) issue is tackled, the sale of MFs through agents is unlikely to take off in a big way.
Some insurance companies are hoping that the more serious distributors will be able to survive and prosper by concentrating on traditional products where costs are still not regulated and the intermediary margins are relatively high. The returns to the policyholder in a traditional endowment (or money-back) product is nothing to write home about since a significant percentage of the funds are required to be invested in fixed income instruments and also the high costs (including high distribution costs) associated with this instrument. This is unlike Ulips, which even in the past (with higher expense ratios) was justifiable as a good investment option as long as the customer continuously invested for at least 12-15 years. The traditional plan is difficult to justify as a good investment option under any assumption. Based on past performance, it is unlikely to beat a combination of a term plan and PPF under any scenario. Some distributors, no doubt, will make a successful switch from selling Ulips to traditional policies. But an industrywide success will, ironically, cause its own downfall. The media will immediately highlight the deficiencies of the policies as an investment instrument and after some time, the insurance regulator will probably be forced to come out with cost restrictions on these policies as well.
In fact, it is quite possible that the upfront commission on MFs may be brought in again through a slightly different route to make them more amenable for sale by the distributors. Even the Pension Fund Regulatory and Development Authority has set up a committee to recommend ways of making the product more popular among the general public. One of the recommendations is bound to be allowing reasonable distribution margins.
The conclusion is that investment products in India continue to remain push products. Thus, there is no way that they can be sold without distributors. Reasonable front-end commissions cannot be eliminated if the distributors have to remain profitable and not go back to growing coconuts. The entire market will have to recognize this fact sooner rather than later.
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Harsh Roongta is chief executive officer, Apnapaisa.com