Entry fee ban unsettles money managers

The country’s stock market regulator said earlier this month it would abolish front-end or entry fees charged by mutual funds from 1 August, a move aimed at cutting costs for investors and to discourage aggressive selling.

The ban threatens the incomes of over 87,000 distributors, agents who sell funds for a fee, and bring more than 90% of the business to money managers. It is expected to be particularly hostile to small and new players who depend on agent networks.

Beyond a handful of firms such as Reliance Capital Asset Management and UTI, Indian money managers have limited reach and rely heavily on distributors to build up their client base.

The move will also make it harder for the more than 20 would-be entrants into the market, which is forecast by Boston Consulting Group (BCG) to manage $520 billion by 2015, compared with $120 billion now.

Allianz, UBS and Credit Agricole are among foreign firms looking to set up shop in India.

“It’s bit of a blow ... a lot of the AMCs will have to look back at their strategy," said Sanjeev Gupta, chief executive of the emerging market investment unit of South Africa’s second-biggest insurer, Sanlam.

“It’s not just something that affects newcomers," said Gupta, whose firm is looking to enter the Indian market and had anticipated a ban on entry fees.

For existing players, it would mean taking a hit on revenues to pay agents at a time when sales have dropped and operating expenses have nearly tripled to 113 basis points since 2004 due to higher marketing, distribution and administrative expenses.

The upcoming rule change has led to a scramble to launch funds before it takes effect. Units of Religare, Canara Robeco, JPMorgan, BlackRock and Franklin Templeton are among 10 firms who have launched funds in July.

Longer Profitability Path

Domestic money managers typically charge about 2.25% as entry fee on equity mutual funds, their most profitable assets, and pay the entire amount as fees to distributors.

By comparison, funds charge 3-5% in Singapore and about o1% in Europe and the United States.

Funds also offer 30-100 basis points in yearly recurring fees to agents which comes out of their annual expenses capped at 2.5% of the assets. Funds now fear they will have to sweeten the other commissions and pay entry fees from their revenues.

While the industry is busy figuring out a new compensation model, many expect a hit of about 5 to 20 basis points on annual investment management fees of about 55-58 basis points, depending on how aggressive the large players become to sustain growth.

“The entry barriers have been raised," said Rajnish Narula, chief executive of the Indian fund unit of Robeco.

“For the new player, the break-even gets delayed a little bit more. You need to have the sustaining power which means you need to have capital to be able to delay your break-even," he added.

BCG estimates a firm would need at least Rs100 billion ($2.1 billion) under management to break even.

Of India’s 36 fund firms, only 15 managed assets in excess of $2.1 billion in June, according to data from the Association of Mutual Funds in India.

Distribution Headache

With investors in the top 20 cities accounting for 90% of industry assets, according to KPMG, funds are worried that lower payments will cut the incentive to distributors to expand into smaller markets in order to fuel growth.

Instead, distributors might opt to sell other investment products, such as those offered by insurance firms that could earn them up to 30% of the first premium as upfront fees.

Distributors have already threatened to stop selling funds and said they might go to courts over the fee ban.

“That’s the fear. If you increase regulation of one financial product, people would move to a different financial product which is not necessarily better," said Ed Moisson, director of fiduciary operations for Europe at global fund tracker Lipper.

While the next couple of years will be tough for fund houses and distributors adapting to the new compensation model, longer-term prospects remain bright."

Present Tense, Future Perfect

India had just 0.3% of the $18.97 trillion global asset management industry in 2008, and only 7.7% of its household savings went into mutual funds as compared to 26% in the UK, according to data compiled by KPMG.

With one in every six human beings on earth an Indian and rising income levels of its middle class, already larger than the population of the United States, the country presents a powerful long-term lure for money managers.

In the last two years the Indian fund industry has attracted the likes of JPMorgan, Italian bank UniCredit’s Pioneer Global arm and France’s Axa.

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