Fee arbitrage may have distributors pushing alternative investment funds

An AIF typically resulted in an upfront commission of between 3-3.5 per cent of the assets garnered

A change in upfront fee regulations may mean a switch in what distributors pitch to their wealthy clients.
 
Large distributors may look to pitch more alternative investment funds (AIFs) and fewer schemes under the portfolio management service (PMS) scheme, according to experts.
 
Both are essentially sophisticated products aimed at the wealthy though there are significant structural differences.
 
Recent regulatory changes mean PMS schemes have no upfront incentive for distributors.
 
Daniel G M, founder-director at industry-tracker PMS Bazaar, which also tracks AIFs, said distributors had been seeking information about AIFs. Large wealth outfits are examining fee structures and other factors.
 
“They’ve started evaluating that (segment),” he said.
 
An AIF typically results in an upfront commission of 3-3.5 per cent of the assets garnered. Commissions for PMS schemes are lower by around 100 basis points, noted a senior executive at a wealth firm.
 
Arbitrage increases drastically with the removal of PMS upfront commissions. A distributor can expect to make 3 per cent or more immediately if they sell an AIF instead of the gradual trail commission paid in a PMS scheme.
 
This may result in some shift towards the AIF segment.
 
“Earlier, when mutual fund upfront commissions were removed, the money which wouldn’t have been out of place in either a mutual fund or PMS scheme tended to gravitate towards PMS. One can expect something similar now in favour of AIFs,” said the person.
 
The person said differences between the segments might affect the extent to which the shift happened. The AIF segment comes with a multi-year lock-in and has a minimum investment of at least Rs 1 crore, or twice that of the PMS industry.
 
The Securities and Exchange Board of India recently doubled the minimum ticket-size to Rs 50 lakh. It had also changed the fee structure to ensure no large payouts in the beginning to prevent distributors mis-selling products for short-term gains.
 
“As provided in … the PMS Regulations, no upfront fees shall be charged by the portfolio managers, either directly or indirectly, to the clients,” said the February 13 circular.
 
It added that portfolio managers also had to provide a direct plan, which would allow clients to invest without using a distributor.
 
“Portfolio managers shall prominently disclose in its disclosure documents, marketing material and on its website, about the option for direct on-boarding … At the time of on-boarding of clients directly, no charges except statutory charges shall be levied,” it added.
 
Making the transition could be easier said than done.
 
A portfolio manager pointed out AIFs had ambiguities around taxation, besides a higher minimum investment.
 
AIFs structured as trusts found themselves having to pay 42.7 per cent in taxes after an increase in the surcharge in the last Budget. Investors who can write large cheques required in AIFs also tend to be sophisticated. They are less likely to be swayed by what the distributor decides to push, said the person.
 
There is also a sense that a similar regime may soon be in place for AIFs. So any arbitrage is unlikely to persist indefinitely, according to experts.
 
 

Includes funds from EPFO/PFs, as of January 2020
Category	Assets (in crore Rs.)
Plain Debt	1,433,886
Listed equity	151,434
Mutual Funds	30,316
Others	14,339
Structured Debt	2,320
Unlisted equity	847
Equity Derivatives	505
Source:Sebi Bulletin