How India’s MF ecosystem has evolved since the 90s

Sebi introduced various measures to streamline and make mutual funds more accessible. (Mint)
Sebi introduced various measures to streamline and make mutual funds more accessible. (Mint)


Sebi’s interventions, technological advances have revolutionized the mutual fund landscape

It is one of those days that most Gen X investors still remember vividly. A tryst with history on 16 May 1992. A long, serpentine queue had formed in the heart of India’s capital New Delhi early that morning. The restless queue, which was waiting for Unit Trust of India (UTI) to open its office, soon went berserk and the police had to be called in. And all this happened because UTI, the country’s largest fund house then, had launched a close-ended fund, Mastergain 92, and every investor wanted to lay their hands on it, says Dhirendra Kumar, CEO of Value Research.

The frenzy must have been witnessed in other parts of the country as well, says Kumar. According to a news report later, ‘Master Gain 92’ debuted with 6.5 million investors, a record for any equity fund. Kumar says he has never seen such euphoria around mutual funds since. And other industry veterans concur. The mutual fund (MF) industry has since grown in size and now has assets under management of 46 trillion.

Addressing a conference of chartered financial analysts some time ago, Kumar said the high demand for Master Gain 92 fund was due to the logistical difficulty faced by small investors in buying and selling shares through stock brokers. For them, the easiest way to participate in the markets was by owning mutual fund units, thereby giving them an indirect exposure to equities. At that time, the Harshad Mehta bull run was on in full swing and even ordinary people wanted to participate in the stock markets at any cost.


Graphic: Mint
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Graphic: Mint

All that changed soon. Market regulator Securities and Exchange Board of India (Sebi) introduced various measures to streamline and make mutual funds more accessible. The advent of technology speeded up the process.

Mint spoke to some industry veterans to understand how the MF ecosystem has evolved since the 90s. MF distributors were then called Independent Financial Advisers (IFAs) and could earn heavy commissions in the form of annual charges, entry load, exit load and initial issue expenses. The last was levied during the launch of a new fund— an initial public offering as it was known then. Now, it is a new fund offering. Asset management companies (AMCs) could charge an initial issue expense of up to 6%. This would take care of their expenses and the commissions as well. The entry and exit load commissions could both be as high as 7% and distributors got a part of this as well. To be sure, an entry load is charged when an investor buys a fund and an exit load is charged when an investor sells it.

Gradually, Sebi started working towards dismantling this commission structure. The initial issue expense was removed in 2008. Subsequently, the entry load was abolished in 2009 and it could no longer be used for paying distributor commissions. The exit load had to be ploughed back to the fund’s NAV, or net asset value.

In 2012, the market regulator introduced a beyond-15 (B15) incentive to increase MF penetration. The scheme paid a higher commission for selling MFs to investors beyond the top 15 cities. Around the same time, it levied a fee for MF transactions: 150 for new investors and 100 for existing investors, for every transaction beyond a certain threshold.

Then in 2013, Sebi introduced direct plans whereby investors could buy MF units directly from AMCs, eliminating the role of middlemen and commissions. The same year, it permitted registered investment advisory (RIA). The RIAs are regulated by Sebi and they are allowed to charge a fee but barred from earning commissions on selling regular mutual fund plans.

MF distributors

They have been around since the time MFs were introduced in India. The distributors are individuals or corporations registered with the Association of Mutual Funds in India (AMFI) and can earn a commission on sale of MFs. As of June 2023, there were 1.4 lakh registered distributors—of these, 6,600 are registered as corporate distributors and the remaining are individuals.

A report titled ‘Why World’s Largest AMCs are not present in India’ in August said about 22,000 mutual fund distributors, or MFDs, who individually have assets of more than 5 crore, collectively control 83% of the industry AUM (regular plan). Additionally, 110,000 smaller MFDs (with less than 5 crore corpus) earn a very low annual trial commission, ranging from 1 lakh to 5 lakh. This shows that the distribution business is heavily concentrated in the hands of the top players.

“Choosing MF distribution as their sole profession could be very challenging for new MFDs till their income reaches a decent size. This creates a problem in attracting young MFDs and increasing foot soldiers to improve the MF penetration," said the above report.

Distributors are broadly categorized into three buckets: national distributors (NDs), MFDs (or independent financial advisers), and banks. According to a report by Kotak Institutional Equities, in fiscal 2022, individual MFDs had a share of 17% of the total AUM, whereas national distributors and banks had 49% and 34%, respectively.

Kumar of Value Research said many MFDs operate as wealth managers since Indians are not used to paying fixed fees for advisory services.

Another challenge for investors is the risk of banks hard-selling their own mutual funds and not acting in good faith in recommending the right fund. A previous Mint article pointed out that many AMCs, including HSBC, IDBI and SBI pay out more than 50% of the commission to their sister concern banks (for FY22)

Investment advisers

MFDs, warn market experts, would want to churn your portfolio at regular intervals or cross-sell certain funds to earn more commission. If investors dislike this, they can opt for fixed-fee advisory provided by RIAs, who advise clients on their personal investments.

A fixed fee reduces the incentive to sell high commission products. RIAs consider various factors like risk appetite and needs of the individual and family when building an investment portfolio. But, a high regulatory burden and strict compliance norms have dissuaded many from applying for this license from Sebi. There are only about 1,300 RIAs in the country. This means that the services of an RIA are not accessible for a majority of the population unless they have a huge corpus. Also, of the 1,300 RIAs, 75% are registered in the top 5 cities, with 10 states not having even a single RIA.

Notably, a Boston consulting report in 2018 showed that 45% income of wealth managers globally is fee-based. That number, though, was only 14% for India. According to the report, Indian wealth managers relied heavily on commissions, which made up for 58% of their total income. The report shows that India has a lot of room to grow towards a fee-based model.

Amit Trivedi, co-founder of Osat Knowledge, said RIAs are broadly of two kinds: financial planners and outright derivatives/stock tippers. He said that while the former aligns with Sebi’s objective of providing advice, the rise in the number of derivative tippers in the form of RIAs led to Sebi introducing cumbersome regulations for the RIA community as a whole.

Fintech apps

The launch of direct plans in 2013 sowed the beginnings of new-age fintech apps. These apps could integrate their backend system with registrar and transfer agents such as CAMS or Karvy. Alternatively, they could integrate with exchange-run platforms like BSE Star MF or NSE MF to offer mutual funds free of any commission in 15 minutes, provided investors have the required documents.

Investors can go directly to an AMC’s website or transact from RTA-run platforms. Yet, it was the sleek and user-friendly system of fintech apps attracted a lot of investors. The only problem here was that fintech Apps earn nothing from offering direct plans. So, they aim to get customers hooked to their platforms and then pitch other financial products that bring in revenue. Many experts caution that MF apps could sell products that may not necessarily be suitable for retail investors.

Suresh Sadagopan, RIA and founder of Ladder7 Financial advisor, said it is important for MFDs, fee-based RIAs, and direct plan apps to grow further to cater to the diverse needs of a huge country like India. He also expressed his disappointment that excessive compliance burden has made the RIA’s business unviable.

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