Investors will get direct access to AIFs soon, and for a lower fee | Mint

Investors will get direct access to AIFs soon, and for a lower fee

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Summary

Sebi regulations on direct plan and trial-based commission model aim to empower investors

Investor empowerment just took another step forward. The markets regulator, Securities and Exchange Board of India (Sebi), recently unveiled a slew of reforms for the Alternative Investment Fund (AIF) sector.

Sebi has in the last few months introduced policy changes to regulate the capital markets, including mutual funds (MFs), portfolio management services (PMS) and AIFs. These include new disclosure norms for listed companies, authentication norms for MFs, enhanced obligations and responsibilities for qualified stock brokers, and effective fund management norms for PMSes. The latest round of reforms concerning AIFs aims to increase transparency, curb mis-selling and enable direct investor access without intermediaries.

The AIF sector grew at the fastest rate of 50% CAGR during 2017-2022, as per a Crisil report. AIFs, which have been the preferred investment avenue for high net-worth individuals, require a minimum investment amount of 1 crore and are predominantly driven by the distribution model—investors have to pay a distribution or placement fee.

Investors can now do without these fees. Sebi issued a circular recently asking AIFs to provide a direct plan option to on-board investors without any intermediary or distributor. This will lower investors’ expenses.

For non-direct plans, Sebi mandated disclosure of distributors’ commissions. It also said that category III AIFs cannot have an upfront commission distribution model. For category I and II funds, one-third of the total distribution fees can be paid upfront and the remaining on a trail basis.

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Category I funds invest in start-ups or early-stage ventures. Category III funds, such as hedge funds, employ diverse or complex trading strategies and are permitted to take leverage (borrowing). Category II is a residual category that includes private equity funds and debt funds.

Sebi’s reforms, which will come into effect from 1 May, were part of the consultation paper released by the regulator in February.

Option to go direct

Schemes of AIFs will now have a direct plan option for investors, as is the case with MFs. But, while the expense ratios are fairly standardized for MFs, the fee in the AIF space depends on the fund managers. Usually, they charge a fixed and performance-based fee. Having said that, commissions given to distributors form a part of the management fees (and performance fee sometimes) that are charged to investors, and “typically ranges between 30% and 60% of such fees," said Vineet Bagri, CEO, Athena Investments. Therefore, the management fee for the direct option, going forward, should go down to that extent.

If you are investing in AIFs on the recommendation of a Sebi registered investment adviser (RIA) who is separately charging you an advisory fee, you will be on-boarded via the direct plan only.

“Until now, most AIFs did not have a separate expense ratio for regular and direct plans. The benefit of lower fees was not available to the AIF investor even if the investment was made through an RIA, who has been paid an advisory fee," added Bagri.

Further, experts confirm that there would be different NAVs (net asset value) for both regular and direct plans, similar to how it is for MFs. A proposal in Sebi’s February consultation paper to allot more units to a direct investor did not find mention in its recent circular.

Trail-based commission

The new rules have also brought in clarity to the payment of distribution commissions. Anshu Kapoor, president and head, Nuvama Asset Management, said, “prior to this regulation, no guidance was available to an asset manager as to how to pay distribution commission and how to structure the pay-out."

Kapoor said asset managers had hitherto devised their own mechanism or structure to pay the distributors. With the new measures, category III AIFs shall charge distribution fee to investors only on an equal trail basis. That is, an upfront distribution fee cannot be paid by such AIFs to distributors.

In many cases, as per Sebi, distributors took 4-5% of the commitment amount as upfront commission. Going forward, such agreements will not be entertained. The distribution commission on category III AIFs has to be paid only on a trail-basis over the tenure of the scheme.

“Now, it is a level-playing field for all equity products – MFs, PMS (portfolio management services) and AIFs - where it concerns distributor commission. The incentive for distributors to push sales in AIF for the upfront commission has been taken away and clients will now be recommended equity products based on merit," said R. Pallavarajan, founder of PMS Bazaar.

To be sure, some distributors had opted for commissions to be paid on the trail model even before the proposed regulation.

“Commission is distributed as a percentage of the investment value at the time of payment. The distributor cannot participate in the growth of the fund if the commission is taken upfront. So, there are distributors who opted for only trail model for equity products" added Pallavarajan.

Sebi has not mandated the trail model for Category I and II funds. Here, one-third of the total fees that distributors are eligible for can be paid on an upfront basis and the remaining on an equal trail basis over the tenure of the fund.

“Category one and two products are made up of asset classes like private equity, real estate, private credit, and venture debt funds . These are complex and sophisticated products that involve dedicated selling. The regulator has allowed some leeway for these products," added Kapoor.

For all categories of AIFs, the distribution commission has to be paid by AIFs only out of the management fee charged to investors.

Disclosures of commission

Sebi has mandated AIFs to disclose distribution/placement fee to every investor signing up through a distributor. Mutual funds and PMSes already disclose this information to the investors. “An AIF investor will now be able to distinguish between the cost paid to the fund manager and that paid to the distributor/adviser. This will bring in more transparency," said Sahil Kapoor, senior executive vice president, 360 ONE Wealth.

For this information, an AIF investor can check the private placement memorandum, or PPM, issued at the time of onboarding. This is a primary document in which all necessary information about the AIF is disclosed to investors. It is a standard formatted document across all AIFs.

To be sure, “a mutual fund investor can go through the CDSL/NSDL CAS statement generated for a period to see the distribution amount paid by the fund house," said Rushabh Desai, founder of Rupee With Rushabh Investment Services.

Industry plea

Separately, fund houses and distributors in the AIF sector want the regulator to relax regulations around the promotion of AIF products.

“Today, all AIFs are sold on a private placement basis. Hence promotions are constrained. With the new regulations it would help if data is made available publicly and people are allowed to do research as in the mutual fund Industry. There should be some relaxation now as a direct route is allowed and there is more transparency for investors," added Kapoor.

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