High commissions may eat into profitability of mutual funds

Upfront commissions on record sales set to substantially hit this year's profits, prompting thoughts of a different incentive structure

Fund houses, flush with investor inflows, are staring at a huge commission outgo to distributors this financial year. The incentives for agents and distributors for selling mutual fund (MF) products, on the highest-ever sales the sector has seen, could be high enough to dent the profitability of asset management companies (AMCs).

Equity MF schemes have had inflows or sales of Rs 1.2 lakh crore between April 2014 and January 2015, the first 10 months of this financial year. In the remaining two months, sales are expected to surpass earlier record levels. More, a large portion of the sales this year have come from new closed-end schemes, where the upfront commissions were as high as eight per cent. Typically, AMCs pay an upfront commission of about 1.5 per cent in the equity segment to distributors. The sector also paid between five and eight per cent of 70-odd closed-end new fund offers launched this financial year, which garnered a little over Rs 13,000 crore in all from investors.

What puts these entities in an awkward position is that these commissions have to be paid upfront, while the fund houses reap the benefits from the investors over three to five years. Rough calculations show the commission outgo on fresh flows in the equity segment could be in excess of Rs 2,000 crore this year, over and above the commission on previous investments. The commission paid was Rs 2,600 crore in 2013-14. This included commissions paid on debt schemes, which account for almost 80 per cent of the total.

Also, the commission to be paid this year is much higher than the combined profit of the top 10 AMCs in terms of size. The top 10, which manage nearly 80 per cent of the sector's assets, had a combined profit of Rs 1,600 crore in 2013-14. “This kind of payout will be far higher than what the entire industry put together makes,” said Dhirendra Kumar, chief executive of fund tracking firm Value Research.

Those in the sector said the strong flows were good for the segment but the benefits would be over a period of time. “For the time being, the industry is taking a hit but in the coming two or three years, we will make money on it, provided the assets stay,” said a senior official at a large fund house.

He said this year's flows were more than what had been anticipated. “I can't rule out the possibility that it might hurt the profitability of some players which have got the largest flows of equity assets. But that's the nature of this business. Pay now, reap later,” he added.

The MF sector is considering a move to a new commission structure, where the upfront or initial amount paid to distributors is lower than the trail commission, which is paid only if the investor stays with the scheme. “After the lessons learned this year, the industry would not like to front-load the commissions,” said the official quoted earlier. The total of AUM of the domestic fund sector was Rs 11.81 lakh crore at the end of last month.