Trailing payouts catch Sebi attention, regulator examining divergence

The Securities and Exchange Board of India (Sebi) could take a re-look at the trail commission structure of mutual funds (MFs).

This is part of its examining instances of divergence between first-year and subsequent commission payouts in some MF schemes, according to people aware of the matter.

Sources suggested the divergence in first and subsequent trail payouts had been 45-50 basis points.

According to industry participants, divergences in such schemes happened after fund houses were debarred from offering upfront commission, and some of them are using the grey area to incentivise distributors through higher trail in the first year. “In the absence of upfront commission, some fund houses have adjusted their first-year trail,” said a senior executive of a fund house.

Experts say such a move could dent the purpose of debarring upfront commissions.

“Upfront commission was scrapped with the aim of curbing a portfolio churn. Large distributors in particular nudged their clients to shift schemes to gain from upfront commission,” said a fund manager.

Upfront commissions were offered as one-time payment to distributors for selling an MF product. “While the trail model is still better than upfront — which was a clear incentive to churn investor portfolios — there is a need to iron out any further grey areas in commission payouts,” said a member of Sebi’s 19-member Mutual Fund Advisory Committee.

On the differences in trail commissions, Madhabi Puri Buch, whole-time member of Sebi, said: “This has recently come to our notice as to how trail commission is being structured. We will look into it.” 

She was speaking on the sidelines of Sebi’s board meeting on Monday.

The MF industry has seen a slew of changes in the past couple of years to protect investors’ interests and reduce the cost of investing.

The regulator has pulled up fund houses for “unfairly” slapping higher fees upon investors coming through direct plans, where there are no intermediaries and hence there is no need to charge them for commission payouts. To ensure there is no scope for one set of investors bearing the cost for those coming through a different investment mode, the regulator also made it mandatory that fund houses book scheme-related expenses in the same schemes.

In 2018-19, MFs’ payouts to distributors through commissions and other distribution-related expenses dropped 7 per cent to Rs 7,938 crore, following the scrapping of upfront commission by the regulator.

Private banks that offer distribution services saw a sharp reduction in distribution income because their business models were largely oriented towards upfront commission. Such banks saw 7-20 per cent dip in their commission. 

Apart from scrapping upfront commission, Sebi has capped maximum commission payouts to bring down the overall cost of investing.

The expense ratios — charges borne by investors — have also been linked to scheme size to pass on benefits of scale to the end investor.