Several of the decisions announced by the Securities and Exchange Board of India (Sebi) recently with a view to “re-energize" the mutual funds (MFs) industry stand imperilled by the clause that mandates MF companies to create a direct plan variant for their schemes. Such a variant would be available only to those who are investing directly with the MF companies and would be available at a lower expense ratio.

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This move could have significant negative ramifications on the industry, the marketplace and, ultimately, the investor. Prima facie, it would appear that the investor stands to gain from such a clause. However, in the long term, it would be harmful to their interests as well.

It may lead to unhealthy conflict

Such a product creation would put manufacturers in conflict with distributors. For any industry’s eco-system to operate successfully, there needs to be co-operation between participants of different types and competition between participants of the same type. That is, while competition between AMCs or between distributors is good, there needs to be co-operation between AMCs and distributors. This is an elementary principle of industry economics.

However, with the forced creation of a direct plan, competition is being created between manufacturers and distributors. And to make it worse, it is not a fair competition given that one side is given a mandatory cost advantage.

Is it new?

It is not as if a direct option does not exist already and Sebi is creating a new avenue for product distribution. As we very well know, any investor can approach AMCs for direct investments even today. The fact that a negligible percentage of people do so is testament to the fact that advised/facilitated services are determined to be superior by the market compared with the direct approach.

Cheaper may not be always better for customers

It could be argued that if the service providers really add value, investors would continue to choose it regardless of lower costs. They might, but my experience in this market tells me otherwise. And I would not even blame the investors in this regard. Service—be it advisory, aggregating, value-add, or something else—is always hard to quantify in monetary terms. And it is impossible to argue against “zero"—an investor will always rationalize to themselves that the cheaper option is better (I can choose my own funds, I can track the portfolio using a spreadsheet and so on) even if in the long run it would work against them and lead them to have poorly managed portfolios.

Is it really fair?

One could raise the “fairness" doctrine and say that direct investors should not have to bear the cost of distribution. This is a bogey, especially in a country like India. In the same set of announcements that Sebi made, there is a clause about increasing the total expense ratio (TER) for all investors to promote and incentivize distribution in non-tier-I cities. What is “fair" about this? If this is fair, then why cannot one make the argument that savvy and self-serving investors should bear some cost for educating or advising people who are not so investment-savvy?

Indian MFs are cheaper than that in other countries

As it has been pointed out time and again, Indian MFs have among the lowest total ownership costs in the world. While other countries’ fund industries have multiple headings to hide their costs under while projecting low fund management fees, in India, investors are protected from such shenanigans by having only one expense ratio to deal with. And apples to apples comparisons have always shown that MF investors are better off in India in terms of costs compared with developed countries.

Speaking of other/developed countries, our regulators often cite regulations in the US, the UK and Australia. Can somebody tell me which other country has a mandated lower expense ratio for avoiding distribution channels?

Blow to distribution

Finally, but definitely not insignificantly, this move and this way of thinking is a blow to innovation at the distribution level. All over the world, a new kind of product distribution and intermediary function is evolving, especially with the use of technology. When the regulator, whose role it to foster innovation, throws in an unfair competition, it is the worst thing it could do to stifle such new ways of thinking.

So, essentially, what Sebi has done with the direct plan proposal is create competition between entities that need to be partners, create dilemma in the minds of investors between a sound choice and a cheap choice and create dampeners to innovations in the marketplace. They should rethink the idea.

Srikanth Meenakshi is founder and director, FundsIndia.com.

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