Fenil's Library

The regulator could have done better for sure

Sandeep Shanbhag

Most equity mutual funds charge retail investors an entry load of 2.25% on their investments. This entry load is mandatorily payable irrespective of an investor's mode of entry. The total amount collected as load for each scheme, as per Sebi stipulations, has to be maintained in a separate account by AMCs and can be utilised to meet selling and distribution expenses. As per industry practice, the load is normally utilised for paying the agent/ distributor's commission.

Now, in an effort to bring about transparency in payment of commission to mutual fund distributors, Sebi has decided that there will be no entry load for the schemes, existing or new, of a mutual fund. The upfront commission to distributors shall be paid by the investor to the distributor directly. Moreover, the distributors shall disclose the commission, trail or otherwise, received by them for different schemes/ mutual funds which they are distributing or advising the investors

Sebi has over the years done an excellent job of regulating the mutual fund industry and making it adopt international best practices as far as possible. The waiver of load is a similar welcome step that will no doubt benefit the small but informed investor.

However, when I try and look beyond the obvious, I find certain creases should have been ironed out before implementing this move, which essentially facilitates a small minority to access a cheaper product that a vast majority has little knowledge of. While providing the informed investor with choice is a desirable objective, protection of the uninformed investor's interest is critical.

Also, is it appropriate that the load waiver is made applicable to mutual funds in isolation? There are other investment products, which for all practical purposes are mutual funds, only not called so.

Take the unit linked insurance plans (Ulips) of insurance companies. These are nothing but mutual funds that charge far higher loads (from 15% to 75%). Of course, the charges come down over the tenure of the investment, but the point is that those charges clearly exist. Moreover, of late, the way Ulips are advertised and promoted, it is difficult for an uninformed investor to differentiate and tell apart a mutual fund from an Ulip. Then there are structured products issued by portfolio managers and large broking houses, which too are nothing but mutual funds that offer substantially higher fees to distributors.

In such an environment, where products with similar functions co-exist, albeit with vastly dissimilar incentive structures, there is bound to be wholesale shepherding and forced migration of uninformed investors to such products. In other words, there is a clear and present danger that the mutual fund industry will end up subsidising competing investment products.

This is not to say that the load should not be waived. Only that it should be done across the board, not selectively.

Admittedly, this is easier said than done since the regulators of both industries (Sebi and Insurance Regulatory Development Authority, respectively) differ. However, if any practice is deemed desirable, it should be so notwithstanding the industry concerned. Efforts must be made by the respective regulators to impose best practices in respect of their products uniformly.

Secondly, the three affected parties basically are mutual funds (AMCs), distributors and investors, both informed and uninformed. Though the immediate interests of each of these constituents may differ, they do indeed have a common objective — that of growth and development of the mutual fund industry. The more the industry grows, the better the technology and skilled manpower that AMCs can afford, thereby engendering more competition and better returns to investors both uninformed and informed. However, if the pipe is made narrower only at the beginning, other (quasi) mutual funds will take over the market to the detriment of the uniformed investor.

The Sebi press release keeps it short and sweet by mentioning that the commission should be paid by the investor to the distributor directly. Is this practical? It is only in a perfect world that the uninformed investor will pay separately for the advice and service he is getting. More often than not, the uniformed investor is uninformed of the fact that he is uninformed. A fee structure open to negotiation will lead to fee shopping, with distributors indulging in blatant rebating just to get additional business and the associated trail commission.

That said, I cannot emphasise enough that it doesn't mean a knowledgeable investor is forced to pay someone for services he doesn't need. For such persons, the system of bypassing the distributor and investing directly is already in place. The only submission is that imputing the investor with the responsibility of compensating the distributor will confuse and corrupt the market place. In other words, prima facie, though the immediate effect of this move seems to affect only the distributors, over time it will hurt the mutual fund industry as a whole. Consequently, at the end of the day, it is the small investor who will be left disadvantaged — that's ironical, considering it is for his benefit that this entire fuss started in the first place.

As a consumer, I too look forward to cheaper financial products. However, I hope the authorities come to a decision after careful consideration of issues such as those laid out in this column. For, as an informed investor, I don't want to end up saving two but paying twenty.

The writer is director, Wonderland Consultants, a tax and financial planning firm. He may be contacted at sandeep.shanbhag@gmail.com