MFs pay advance commissions to beat new cap

1% cap on upfront payments to take effect from April 1; fund houses rush to beat cap

 

Mutual fund houses continue to tinker with innovative ways to lure distributors toward selling their products. According to sources, asset management companies (AMCs) are paying distributors ‘extra’ commissions ahead of the April 1 deadline for the new payment structure.

However, the extra paid is nothing but advancing of upfront and trail commissions for the next two years. Starting next month, the Association of Mutual Funds in India (Amfi) has proposed to cap upfront commissions within the upper limit of one per cent, as best-practice for the Rs 12 lakh crore MF sector.

Fund houses are offering extra commissions to the extent of 50 basis points (bps) for the next two years, resulting in a total outgo of 100 bps. This is not restricted to new fund offers but existing schemes as well.

PAYING THROUGH THE NOSE

• Amfi has suggested upfront commissions be capped at one per cent from April 1
• Asset management companies paying distributors advance commissions ahead of April 1
• Fund houses offering advance commissions up to 50 basis points (bps) for next two years - a total outgo of 100 bps
• Experts say the practice violates Amfi’s proposal
• Extra payout to reflect in the accounts of the current financial year

Sources said a select group of distributors, mainly the larger ones - were tying with fund houses under this scheme.

Such activities mushroomed within a few weeks of Amfi’s proposal to cap the upfront commission at 100 bps, or one per cent. The industry lobby had also asked fund houses not to upfront the trail commission, as was the case in many of the recent close-ended equity related schemes.

Fund houses had agreed that the quantum of trail commission should not be more than the upfront.

Currently, trail commissions vary between 40 bps and 75 bps. Taking this into consideration, if the upfront paid is 100 bps, the overall commission, including trail, would be restricted to 1.5-1.75 per cent after this month, once Amfi’s proposal comes into force.

However, by advancing the commissions, the total amount being paid will touch 2.25 per cent. MF executives said the extra payout would reflect in the accounts of the current financial year.

Some players feel there is nothing wrong in this practice, as fund houses have the fungiblility to use the total expense ratio (TER).

However, others argue the practice is in violations of proposal by Amfi, which has asked not to upfront the trail. Further, with 2.25 per cent as commission outgo, the payout will be much more than the 1.5-1.75 per cent.

According to Amfi, the trail commission in the first year will be based on the balance of TER, after deducting the upfront commission and the operating expenses.

Dhirendra Kumar, chied executive of fund tracking firm Value Research, said, “Firstly, there should not have any cap on the commissions AMCs can pay. It is up to the AMCs to decide. High commissions are an unhealthy practice, which can potentially create a distortion in sales practices.”