Business Standard

Will the industry survive the 'Direct' attack?

Distributors are scared, funds are developing cold feet, but a great new era may soon dawn for investors if Sebi stays firm

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Three years after the game changing moves that put the focus on mutual fund investors, the market regulator announced several changes to the mutual fund regime. This time, the Securities and Exchange Board of India (Sebi) appeared to have balanced these measures very well.

The manufacturers of the product i.e the fund houses were allowed to charge up to 20 basis points more across schemes. The distributors would get a share of this increase, so they were also supposed to be happy. And, then for the investor two major sops were offered. First, the clutter in the industry was to be removed by eliminating multiple plans in schemes. Secondly, the funds were asked to create a new plan under which investors can bypass the distributor and buy the scheme directly. This elimination of intermediary was to result in a few basis points savings in the hands of the investor.

Now, while the fundhouses have happily lapped up the extra expenses by increasing charges with effect from October 1, they seem to be developing cold feet in executing the other half of the promise. Instead of addressing technical issues that may arise and rolling out a definite roadmap for implementation of the direct plans for which the extra three months were given by Sebi, some senior managers seem to be spending time in limiting the scope of these Direct plans.
 

WHAT HAS DONE
  • Allow higher TER of nearly 20 bps across schemes
  • Allow AMCs with significant assets outside top 15 cities charge up to 30 bps more
  • Eliminate multiple plans in schemes wef Oct 1, 2012
  • Create a new direct plan wef Jan 1, 2013 
  • The difference in charges should be equal to selling expenses
  • But no fixed formula given to calculate charges for direct plan
IMPACT ON DISTRIBUTORS
  • Higher TER may translate into higher commissions
  • Agents in smaller towns may get better rewards
  • Direct plan at a lower cost may kill business
  • Investors may begin asking kickbacks to stay with distributors
  • Investors may make uninformed investments and incur loss 
INVESTORS
  • Low cost Direct plan good for investors
  • Final form will determine how good it is
  • No clarity yet on the charges
  • Higher costs outside top 15 cities may affect returns
  • Direct plan must be easy to use

Distributors have gone a step ahead and submitted a memorandum to Sebi wanting to scrap the idea. The distributors feel that the direct plan will lure investors away from them. They believe that investors may take advice from distributors for about, say, 20 per cent of their portfolio and then replicate the advice for the remaining.

According to a memorandum submitted by IFA Galaxy, a distributors federation that functions online, “Mutual Funds as a concept was introduced to cater to those investors who are not savvy enough to make their own investments in equity markets. While direct equity option is available for savvy investors through a huge network of stock broker and sub-brokers across the country, what is the need for introducing a direct share class in Mutual Fund investment? If an investor is savvy enough, he would anyways prefer a direct equity investment. Is this not defeating the very premise on which mutual fund investments were introduced?”

The distributors also argued that without proper guidance from the advisors, investors will not be able to chose from 44 fund houses offering multiple schemes. “How would an investor make the right choice and decide on the right scheme for his investment among the maze of options available to him? Under these circumstances would he not be confused and make a wrong choice? If he loses his money due to his own wrong choice, what are the chances that he would ever come back for a Mutual Fund investment in the future? Are we not running the risk of losing an investor permanently? On one hand an IFA does all the ground work and sources an investor, on the other hand due to lack of guidance, in doing a direct investment, if he loses his hard earned money, he would leave the system. This would result in a leaking bucket situation. How would this help in increasing market penetration?” the memorandum said.

However, Ajit Dayal, chairman of Quantum Mutual fund, which had done away with distributors years before Sebi announced the plan, has a different view, “As India’s first and only direct-to-investor mutual fund house, we have always realised the potential of the low-cost direct plan of investments. It will help the investors to save the additional cost they pay for the distributor’s services. We believe that the direct plan is one of the more positive steps that SEBI has taken for the benefit of investors. Investors are known to do their research and know which funds they wish to invest in, they do not need to unnecessarily pay large sums of money to distributors for filling in forms.”

Dayal points out how the costs are the only factor under the investors’ control. “Investors must recognise that every fund house can have good returns at some point in time – but returns are not known. Costs are known and defined. The lower the cost, the more of the investor’s money finds its way into the market to try and generate returns,” he added.

While Sebi has said the direct plan has to have lower costs, it has not given any specific formula to define how lower this should be and whether this should be uniform or funds can use their discretion.

Industry officials point out that the agenda papers published by Sebi indicated that the difference in costs between the direct plan and the one sold by distributors will be equal to the amount of selling expenses incurred by the fund house including distribution commission and marketing expenses.

This is Sebi’s cleverly bowled googly, say experts who have read the fine print. “On the one hand, Sebi has allowed you to charge more and spend more on distribution, especially in areas outside top 15 centres. Now, if under the direct plan, you are going to exclude this entire additional expenditure, it could create a huge differential, which investors cannot ignore. The dilemma for funds now is whether they can afford to put their meticulously built distribution networks on the guillotine,” he said.

Arjun Parthasarathy,former fund manager and editor of investorsareidiots.com also said, “Funds do not want to displace the distributors. Distributors get bulk of their incomes from servicing corporate and high net worth investors. If they go direct, many have to shut shop, that is why they are fighting tooth and nail. To some extent, funds are also cagey.”

Dayal added, “while the direct plan might not adversely affect the economics of the industry as the money is anyways flowing in, the real challenge here is how the AMCs will pacify the distributor in case a customer introduced by him makes additional investments into the direct plan.”

People in favour of the proposal also point out that distributors have no reason “to grumble about the introduction of the direct plan as even earlier an investor could always go directly to the AMC regardless if he was introduced by any distributor or not.”

While investors are allowed to invest directly, there is no concession in charges in this mode.

Industry sources said that some top fund houses are proposing a move wherein the direct plan is limited to QFIs and such institutional investors, whereas the corporates and HNIs and probably retail, the community serviced by distributors does not get affected. It is also learnt that discussions have happened in the industry lobby, Association of Mutual Funds of India (AMFI), about restricting the scope of direct plan. But it is not clear at what stage these proposals are and whether Sebi will entertain these.

Dayal of Quantum is against any such move, “the Indian Mutual Fund industry has traditionally been driven by the distributors. While the AMCs might feel insecure about the interest of distributor in selling the mutual fund scheme with the introduction of the Direct plan, we believe it may not be right to limit the direct plan option to only a few institutions or categories of investors and neglect the retail investors.”

He added that the industry should not focus on whom they are selling to but whether the industry is selling the right product to the investor or not. Fund houses need to go back to the fundamental question of whether they are serving the investors’ interests or not.”

Parthasarathy said even if the direct plan was introduced it would not result in a rush for funds “unless market is doing well and investors see value.” He pointed out small retail investments in mutual fund is not very high. “But people are familiar with the direct plan in the insurance sector. They may start looking at the direct option, provided it is as easy as operating a bank account.”

That may entail some costs, points out Vijay Mantri, CEO, Pramerica MF. “Direct selling also comes with some costs for the manufacturer in terms of putting up the necessary infrastructure,” he said indicating that lower expenses may not mean “very low.”

While the Direct debate rages on, critics are also worried about the impact of the move to allow fund houses to charge an additional Total Expense Ratio (TER) (up to 30 basis points, if 30 per cent of their net sales take place beyond the top 15 cities (100 basis points make 1 per cent)) depending upon the extent of new inflows from locations beyond top 15 cities (Claw back of additional TER if the investments are redeemed within a period of one year).

“This means that the total expense ratios for any money coming from other than the top 15 cities can be hiked to 2.8 per cent instead of 2.5 per cent for equity schemes which will thus reduce investor’s capital returns. This increase in costs is excluding the increase in TER allowed by SEBI which is also discussed subsequently. “We at Quantum believe that while it is important for the mutual fund industry to improve its geographical reach and bring in long-term retail money from smaller towns, like any other businesses it should have been the AMC who bears their expansion cost rather than the investor paying additional TER. SEBI’s intentions behind this move are good, but we are unsure if AMCs will use this additional amount to expand their penetration in the tier 2 and tier 3 cities diligently. Moreover, unnecessary branch opening by the AMCs in the race to garner assets (as has been evidenced in the past) may eventually lead to mis-selling for the schemes.”

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