Sebi raises red flag on massive commissions in large MFs' margin maths

Market regulator says reason for lack of meaningful margin expansion at large AMCs could be due to large commission payouts to distributors

The Securities and Exchange Board of India (Sebi) has raised the red flag on large fund houses’ range-bound profit margins while rationalising the total expense ratio (TER) for the mutual fund (MF) industry.

In the board meeting agenda note on review of total expense ratio (TER) of MF schemes, the market regulator said the reason for the lack of meaningful margin expansion at large asset management companies (AMCs) could be due to large commission payouts to distributors. 

Last month, Sebi had announced new slabs for charging TER. Equity schemes with assets of up to ~5 billion could charge 2.25 per cent TER. Earlier, regulations allowed 2.5 per cent TER for the first Rs 1 billion of an equity scheme’s net assets.

“It may be surmised that one of the major reasons for profit before tax (PBT) margins of large AMCs remaining constant is possibly due to a large amount of commission paid from their own books to garner more assets under management (AUMs),” the market regulator said while submitting the proposal for reviewing the TER structure.

According to data collated by Sebi, the PBT margin for large-sized mutual funds has largely been in the range of 41-46 per cent in the last eight financial years. In the period between FY11 and FY18, PBT margin of mid-sized MFs rose from -2.14 per cent to 25 per cent, while PBT margin for small-sized MFs was up from -129 per cent to 0.36 per cent in the same period.
 

Sebi categorised large MFs as those which accounted for over five per cent of industry AUM. Those with AUM between one per cent and five per cent were categorised as mid-sized and those with assets of less than a per cent of the industry AUM were categorised as small-sized.

Interestingly, the growth of mid- and small-sized MFs only made a marginal dent of 52 basis points in large MFs’ market share, which stood firmly at 68 per cent in FY18. Between FY11 and FY18, large-sized MFs saw their assets grow at compounded annual growth rate of 17 per cent, a shade below the growth seen by mid-sized MFs and 233 basis points higher than smaller players.

According to sources, Sebi’s detailed study on the industry’s financials paved the way for the cut in TER.

“When these observations were put before industry participants, there was not much debate as Sebi had done elaborate groundwork,” said a person with the knowledge of the development.

In the board meeting agenda note, Sebi has also flagged off a set of unhealthy practices followed by certain industry participants.

In its board meeting note, Sebi also highlighted that the share of commission as a percentage of AMCs’ books had risen sharply between FY14 and FY18 – from 11 per cent to 22 per cent. The regulator observed that this was mostly upfront commission or upfronting of trail commission, as a percentage of industry revenue.

What Sebi's new circular says

• Upfronting may be for total SIP inflows of up to Rs 5,000 per month
• Upfronting will be up to 1% of the total SIP inflows for a maximum three years 
• A detailed guideline will be issued later  
• Till 'retail investor' is defined, additional TER to be based on 'B30' individual investors