MFs may no longer be top draw for banks after Sebi trail commission order

Shift from upfront to trail commissions could see banks as well as other distributors push sales of insurance, PMS and AIF

Mutual funds (MFs) might no longer be the product of choice for large distributors such as banks, after the regulatory order for a shift to trail commissions.

The Securities and Exchange Board of India had in a circular dated October 22 introduced a slew of changes aimed at bringing transparency in expenses, reducing of portfolio churning and mis-selling. This was one of the objectives in the scrapping of upfront commission. 

While several independent financial advisors (IFAs) had shifted to the trail model of receiving commissions over recent years, large banks and national distributors (NDs) were still being compensated through upfront commissions for selling MF products. 

Such commissions are paid immediately on sale of products, enabling banks and NDs to pay and also incentivise their relationship managers commensurate with the revenue they bring in. Trail commissions, on the other hand, are paid annually and tied to investment tenure. “Any entity which has a high fixed cost or an incentivisation plan linked to monthly revenues might lessen their focus on MFs, going forward. New IFAs or those with a relatively small asset base might turn to other products or give up selling MFs altogether,” said a sector official, on condition of anonymity. 

Apart from MFs, banks typically hawk insurance products, portfolio management services (PMS), alternative investment funds (AIFs) and structured products. Sales of these could gain at the expense of MFs, especially in the case of private and foreign banks, said experts. Banks focused on individual investors might start pushing unit-linked insurance products (Ulips) and endowment ones to buttress upfront revenue.

 AIFs and PMS charge a recurring annual fee of, say, 1-2.5 per cent. A portion of this is paid to distributors as commission. High upfront commissions are prevalent in traditional life insurance policies, of 35-40 per cent in the first year. In the case of Ulips, the agent commission is six to seven per cent in the first year and drops subsequently.

New IFAs, too, could get dissuaded from selling MFs, given the prolonged period for breaking even. IFAs with a sizable corpus, however, might stick to selling these, as most had already shifted to trail commissions a few years before and can generate a steady income stream from the existing client base. 

“Those who diversify to other products might do so to generate a secondary source of income, not to replace MFs as their primary offering. Those with a corpus less than Rs 200 million might have to do a rethink,” said an IFA, on condition of anonymity. An IFA operating in a tier-3 or tier-4 city, for instance, typically would want to generate a monthly income of Rs 30,000-40,000. This would require him or her to create an asset base of Rs 30-50 million. For an IFA just starting, building this could take at least a year. 

According to Swarup Mohanty, chief executive of Mirae Asset MF, trail commissions can approximately match the upfront plus trail model over three years or more. “I do not think banks’ revenues will get impacted but they will have to adjust their cash flows. That said, things might change once the quantum of commissions come down,” he said.

The amount of commission paid could reduce once the change in total expense ratio, or TER, comes into play. The regulator has capped the TER for fund houses with equity assets of up to Rs 500 billion at 1.05 per cent, against 1.75 per cent earlier. TER for lower assets has also been slashed, slab-wise. That for closed-end equity-oriented schemes is capped at 1.25 per cent. A final notification for TER is expected in the next few months.

 

Money ball

•  Large banks, few national distributors still rely on upfront commissions
•  May aggressively push insurance, AIFs, PMS after upfront ban
•  MFs paid more than Rs 85 billion in commissions in FY18
•  Seven of the top 10 earners were banks, which garnered Rs 29 billion
•  Break-even period for new IFAs to stretch further after the ban