Ban on entry load may impact AMCs: McKinsey

The ban on entry load on mutual fund products could impact distributors and asset management companies (AMCs) in terms of profitability and reduce their reach beyond urban centres, according to a report by the management consulting firm, McKinsey & Company.

The Securities and Exchange Board of India (Sebi) has banned the entry load charge on mutual fund products from August 1. Now, distributors have to negotiate with customers for commission, which is to be paid through a different cheque.

During FY09, industry profitability dropped from approximately 22 basis points (bps) to 14 bps. One basis point is one-hundredth of one percentage point. "In short term, there will be a sharp decline in profits," the report said.

According to a chief executive officer of a foreign mutual fund, current profitability will certainly be around or below 10 bps. He further added that industry would have to work with a wafer-thin margin.

The commission paid by customers would depend on the channel of distribution, the report added. "The impact of the regulation may be the most severe on independent financial advisors (IFAs), especially the smaller ones, as they have the least ability to charge for advice. Unless compensated by higher volumes, IFAs may face a revenue loss of 30 per cent," it said.

Banks and national distributors, according to the report, might be better placed to charge customers approximately 100 bps for mutual fund transactions and advice. AMCs, to continue the sales push, might have to compensate distributors for reduced commissions to some extent.

The report also pointed out that a churn in equity assets was expected to come down with customers becoming completely aware of the commission to paid per transaction.

The recent regulatory changes were also likely to create potential for consolidation. "The industry is likely to witness consolidation as smaller AMCs may not be able to accommodate the acute profit and loss stress," said the report.

McKinsey has pointed out that various categories of mutual fund products might have differential growth. It said, "Within equity, the prevalence of closed-ended funds will increase, with AMCs driving for low churn ratios."

It added that the emergence of debt products within the retail segment might receive further impetus with the narrowing down of difference between equity and debt profitability due to higher payouts.

On poor penetration in the rural sector, the report said that with IFAs facing a major impact on profitability, penetration beyond top cities could slow down.