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How MF distributors earn their commission

Distributors continue to be paid upfront fees and trail fees

After the capital markets regulator, Securities and Exchange Board of India (Sebi), abolished entry loads with effect from August 2009, it made it mandatory for mutual fund (MF) distributors to disclose the fee that they earn from MFs. Also, as a result, distributors were also asked to charge their customers directly.

In the meanwhile, distributors still continue to be paid upfront fees and trail fees, which now forms one part of distributor’s earnings. The other part, of course, is the fee they charge you—the investor.

But about the fees that your agent earns from MFs, wouldn’t you like to know how they earn commissions? This is not about how much they get paid individually, but it helps to understand how MFs deal with their distributors.

Upfront and trail

Let’s get the basics out of the way first. Equity schemes charge as much as 2.75% (limits were enhanced in 2012, up from the earlier 2.50%) every year to its unitholders; debt funds charge up to about 2.50%. As the scheme’s size goes up, the expense ratio comes down. Let’s say your equity fund’s expense ratio is 2%. Of this, say, the fund puts aside 25 basis points (bps) for custody charges, registrar and transfer charges and audit fees. A basis point is one-hundredth of a percentage point.

This leaves 1.75%, of which, say, your fund gives some portion to agents as commission and keeps the rest as its own income, also known as asset management company (AMC) fees. Assume your fund decides to give about 0.75% as upfront fees and 0.50% as trail fees. While your MF pays upfront fees to distributors at the time that he gets fresh investments, it pays trail fees to distributors for as long as you stay invested. What remains (50 bps) is your AMC’s own income.

In reality, your fund house pays different commission to different distributors. Pricing also varies from product to product. Dhruv Mehta, chairman, Foundation of Independent Financial Advisors (FIFA), one of India’s largest distributor associations, says: “Products that have the potential to generate higher returns also pay higher commissions. Also, higher the volatility, higher will be the commissions because such products are also difficult to explain to the investor; more effort goes by the distributor to explain its nuances."

As a ballpark, fund industry officials say that equity funds pay 75-100 bps as upfront commission and another about 0.50% as trail fees. Debt funds pay 50-75 bps as upfront charges and about 40-50 bps as trail fees.

“Fees paid to distributors from the ‘beyond top 15 cities’ are higher than what distributors get in the top 15 cities", says Kalpen Parekh, chief executive officer, IDFC Asset Management Co Ltd.

Get paid as per category

Higher the business a distributor gets, higher are his or her rewards. Typically, banks and national distributors get paid the most because of the sheer volume of investments that they get, but many independent financial advisers (IFAs) who have grown their businesses in recent years have also seen a rise in their fees and commissions.

Fund houses, then, classify these distributors in categories. For instance, Reliance Capital Asset Management Co. (AMC) Ltd classifies its distributors as silver, gold and platinum with silver being the lowest category and platinum being the highest. “We look at their existing assets under management with our fund house. But that’s just one aspect. We also look at their potential, among a few other things," says Sundeep Sikka, chief executive officer, Reliance Capital AMC. DSP BlackRock Investment Managers Ltd classifies its distributors as “retail" (at the base level) and then going up to “preferred", “premium" and finally “key relationships" that typically have the largest national distributors and bank distributors.

Your fund house then prepares various commission structures for each of these categories; higher a distributor’s category, more the commission he stands to gain.

Focus and other schemes

Sometimes, fund houses focus on garnering inflows in few and select existing schemes. Such schemes could be small-sized and the fund house may want to grow them in size. The fund house then makes such schemes as its focus schemes. “Here, the fund, typically, pays something extra, say, 25 bps extra upfront, in addition to the usual upfront fees it pays," says Hanoz P. Patel, founder and director, Power Pusher Financial Services, one of Mumbai’s largest distributors of financial products.

For instance, a brokerage chart that we looked at for the April to June 2013 quarter prepared for a bunch of distributors of Reliance Capital AMC shows that the fund house has earmarked three of its schemes—Reliance Top 200 Fund, Reliance Regular Savings Fund–Balanced and Reliance Savings Fund–Debt—as its focused schemes. At the moment, these schemes pay an upfront commission of 1.75% to this bunch of distributors, no trail fees in the first year and 85 bps per annum trail fees from second year onwards. The rest of its schemes pay 85 bps as upfront fees and then 50 bps per annum from the first year onwards as trail fees.

Focused schemes need not necessarily be those whose corpuses fund houses want to increase. They could also be well performing schemes within a fund house. For instance, Birla Sun Life AMC classifies its large and well performing equity schemes as “designated equity schemes A" and the rest of them as “designated equity schemes B".

SIP commissions

One way of paying distributor commissions on systematic investment plans (SIPs) is the same as fund houses pay for lump sum investments. Pay the distributor upfront charges every month, as and when the inflows come followed by the trail fees at the end of every year.

But commissions in SIPs get tweaked slightly. “It takes more effort on the distributor’s part to convince investors to invest in an SIP. Also, the investment amounts are typically small, in the range of 1,500 to 3,000. So by just paying a brokerage to him, it might not help him make his ends meet," says Ajit Menon, head (sales) and co-head (marketing), DSP BlackRock Investment Managers Ltd.

So in addition to the usual upfront charges, some funds houses pay a flat charge per application. Fund officials say that typically some fund houses pay 50 per application if it is a one-year SIP, 100 for a three-year SIP, 150 for a five-year SIP and 200 for a 10-year SIP. These are merely approximate amounts; your fund house may or may not pay such flat charges.

There’s a third mode of payment and that works like this: in addition to the upfront and trail fees, some fund houses pay an additional bonus incentive to distributors. For instance, if 1% is the upfront fee, the MF may choose to pay an additional incentive of 25 bps on all monthly incentives. But there is a small difference. Unlike the usual upfront commission that gets paid after every instalment comes in, MFs bunch up all the months’ special incentives and pay the distributors upfront when the SIP gets registered.

Here’s an example: assume you enrol for a three-year SIP and commit to invest 2,000 every month. Assume your fund pays the distributor an upfront commission of 1% every month (after the instalment comes in on a month-on-month basis) and another 0.25% special upfront commission. This means, that your agent will earn a total of 720 (2,000 x 20/month x 36 months) as upfront commission and 180 as a special commission throughout the SIP tenor. This 180 gets paid upfront to the distributor when the SIP starts. If the investor leaves prematurely, the advance special commission is recovered back from the distributor

Special situation

Usually, equity funds fetch more commissions to distributors than debt funds but sometimes it could be the other way around. For instance, so far in 2013, fund houses have been busy selling their debt funds to capitalize on the falling interest rates.

Between April and June 2013, for instance, L&T AMC is paying a higher upfront fee (1.50%) to select distributors for selling L&T Triple Ace Bond as against 50 bps upfront fee that it is paying to the same set of distributors for selling any of its diversified equity schemes. Several such examples can be found in the market, where commissions paid to debt funds is as much or even higher than what equity funds fetch. “Falling interest rates are good news for debt funds and fund houses want to showcase their income funds to be able to attract inflows. Same is the case with government securities funds. They get aggressive in selling them and hence a higher commission," says Shashank Joshi, a Mumbai-based distributor.

The recent high commissions paid on Rajiv Gandhi Equity Savings schemes is another example because it was a new product and fund houses wanted to popularize it.

Full trail model

Some fund houses such as Franklin Templeton Investments Ltd and Canara Robeco AMC have started to offer the option to its distributors to opt for a full-trail model. This means only trail fees and not upfront fees at all. “These are smart distributors and financial planners who know that their customers will stay invested. These distributors aren’t interested in churning their investors’ money. So they prefer to wait out longer and keep earning trail fees," says Amit Trivedi, CEO, Karmayog Knowledge Academy, a Mumbai-based MF training institute.

Since the distributor doesn’t earn upfront fees, the trail fees are generally higher, for as long as the investor stays invested. Trivedi says that distributors who are new in their businesses and who possibly struggle with their cash flows prefer to get upfront commission and a little bit of trail. But established distributors and financial planners who are interested in “building their business" opt for a trail model.

Trail fees, fund officials claim, are also charged by those who largely charge a fee from their investors. With entry loads abolished, fund industry officials and distributors say a trail model benefits all—fund houses, distributors and investors. While investors are nudged to stay invested for a longer tenor, distributors’ earnings go up in the long run and fund houses get sticky money.

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