Make distributor fee transparent

Some investors believe they are conservative in nature, but expect returns of 15 per cent on their equity investments annually

According to a recent newspaper headline “51 per cent investors withdraw from equity funds within a year.” Nowadays, even a novice investor knows that equity gives ‘excellent returns’ in the ‘long run’. But like the mythical ‘elephant and the five blind men’, the meaning of 'excellent returns' and 'long-term' means different things to different people. 

Let’s look at each one of them separately. In a recent television show, I was surprised when a viewer said that the meaning of long-term to him was one year. Like this viewer, most investors have different interpretations of long-term, but the right answer is, at least, 8-10 years. 

What does ‘excellent returns’ mean? It is misunderstood both for the quantum as well as the manner of getting those returns. So many investors have told me that they are conservative investors, and expect only 15 per cent returns annually. Seriously? Investors need to understand that any returns above the State Bank of India fixed deposit rate carries concurrent risk with it. And risk does not only mean low returns – it implies a loss of capital.

Another issue is that even educated investors who understand that 15 per cent annual returns are excellent returns over 8-10 years assume that they will see a steady rise every year, much like a fixed deposit. What they fail to realise is that despite the very high probability of their getting an excellent return of 15 per cent, if they continue to hold on to their equity over 8-10 years, there is an equally high probability that during some periods the value of their investments will be lower than their cost – in other words, it will be in loss. These investors expect that when the equity markets are doing badly, somehow, their investments will earn fixed returns. And then, when the markets go up, these investments will rise exponentially during good times. This mentality is the biggest reason for early exits from equity mutual funds. Those investors who have been primed to expect losses in the short term will wait it out to reap the rewards in the long term. The others, obviously, don’t have the patience.  

In such a scenario, investment advisors have a serious role to play. In fact, the industry body – the Association of Mutual Funds in India – should disclose the exit rate data separately for advised equity funds and non-advised equity funds. Advised equity funds should include both - direct funds in which the registered investment advisor code is mentioned or regular funds in which the distributor codes are specified – and the rest can constitute the non-advised category. And it is quite possible that the advised category might show less churn during bad times. 

Another thing that needs to be tackled is  transparency in payment to investment advisors. There is no reason why a completely transparent arrangement (such as payment of fees by the cancellation of units), also procedurally and behaviourally convenient, cannot be worked out. Many things such as tax implications would need to be sorted out, but in an environment where many new things have been done in India for the first time, this can also be a pioneering effort. If it helps foster and promotes equity culture among retail investors, it will be worth making an effort. 

The author is a Sebi-registered investment advisor