Mutual Fund Distribution : Pride or Penalty

Since the time the latest SEBI regulations have come on disclosures, a lot of water has flown under. A lot has been written, argued and some Twitter experts have already passed their judgement on how this is the best thing to have happened to the country after Mahatma Gandhi. Oh wait or is it Rahul Gandhi!!!

On a more serious note, disclosures are all good.  How much? Is the key. Imagine a burqah clad woman and you will be intrigued with what is behind the robe. You never know there could be a man dressed as a woman. Opacity is surely bad. But does she need to bare it all completely, to prove that she is a woman? If she does then that my friends, becomes X-rated material. Too explicit for comfort. This is what the latest guidelines have done. They have completely stripped the distributors of comfort. So the account statement will not just mention the brokerage he has made but also tell you the difference between expenses of direct and regular plans. So much porn, sorry I mean so much fun.

The intention is noble, but the action seems not.  

We have a strange habit of aping the West. We look up to the USA as a benchmark for everything that we do. So we have experts comparing costs, load structures of US mutual funds with Indian mutual funds. Ever tried comparing the mutual fund penetration, existence of different share classes and disclosures for distributors/ advisors in the USA or incomplete knowledge is convenient?

How about some statistics:·       

•  An average 45% of US households own mutual funds in USA compared to 2% of Indian households.
• Total Mutual Fund assets in US were at 241 Bn$ in 1981, India in 2016 is at 200Bn$. This data will make no sense until you compare it with the GDPs of both economies. In 1981, US GDP was 3.211 Trln $, which means US MFs were at 8% of GDP. In 2014 US GDP was 17.41 Trn $, the MF assets were a whopping 91% of the GDP at 15.85 Trn$. While as per 2014 data, Indian MF assets stand at 9.75% of 2.05  Trn$  Indian GDP.

Source : ICI Website

So in terms of penetration Indian mutual funds stand almost 

where US mutual funds were in 1981.

The only reason I mentioned these numbers was to highlight, how we try to blindly compare their practices with ours without giving a thought as to how developed that market is and how grotesquely under penetrated we are. Be it the loads, expenses, rush for ETFs (Exchange Traded Funds) or the RIA (Registered Investment Advisor) model.

Why an Advisor / Distributor:

When we need a haircut, we go to a salon. When we need medical help, we go to a doctor. When we need to file a law suit, we go to a lawyer. When we need a well stitched suit, we go to a tailor. Sadly, when it comes to seeking investment counselling, everyone thinks he/she is an expert. The DIY (Do it Yourself) investors who seem abundant on Twitter, must realise that they are a negligibly feeble minority out there. I have conducted many an investor education workshops to come to the conclusion that most people need help. And how on earth can we reach out to masses without enabling distributors?

I shall not make the distinction between an advisor and a distributor at this juncture as I feel we as an economy are not educated and exposed enough to appreciate the difference. The entire notion that a distributor is only interested in making higher commission and an RIA will be holier than thou is a flawed one to my mind. Many IFAs trying to do genuinely good work for their clients are berated for suggesting regular plans. 

RIA model remains the best, but to try endorsing it so aggressively so as to succumb the distributors, we need to understand that a developed market will automatically gravitate to low cost funds and efficient advisory models. Trying to coerce investors by force feeding them information on expenses of direct and regular plans, brokerage payments may only help alienating the investors in an industry which is just trying to find its legs, forget walking or running. I am concerned that ill informed investors may try to do it themselves and hurt their portfolio in the long run My whole worry is the big fish, the so called private wealth managers and private bankers shall still remain unhinged but the small time distributors will suffer.

Ever checked the bill when you pay for any service? The consumer always bears the service tax. When it comes to mutual fund distribution, this tax is also paid by the distributor. Now, if the regulator has decided to disclose his income to the investors, they must also allow the distributor to mention his electricity bill, rentals for running the office, and other costs of running his setup. Why show only the income to the client who will feel entitled to ask for this money back in case he is not asking for it already.

On US Mutual Funds:

Do we know the different share classes for mutual funds in US do not yet allow a small time retail investor to buy without paying a higher entry load or in case of zero loads fund without a higher expense. The investors who can manage a higher amount get benefits of Class 1 shares (similar to our Institutional Plans). Also to benefit on lower expenses, most funds need commitment for a minimum number of years. RIAs though are entitled to buy for clients under Advisory account where expenses are lowest.

Too many permutations and combinations, but the common theme across is: Use a distributor or advisor and pay him or we pay him. Or have bulk amounts for investments to gain the benefit of lower expenses. This is one big reason why low cost ETFs have gained immense popularity in the US. Not to mention the huge data to support how active funds there have been underperforming ETFs.

Coming Back to India:

As a country, we are averse to paying tips unlike most developed countries where tipping is not just a norm but compulsory. Be it in a restaurant, at the valet parking, salon services or any place you can think of, we are bad at making voluntary payments. I know people who do not want to go to good doctors because ‘He is expensive’.  What then makes us think that the people who do not even think beyond Real Estate and Gold will move to financial services easily by ‘paying’ fees? Who then, will educate and inform the prospective investors about the benefits of mutual funds? Why will they not move to more toxic products like market linked insurance plans or to exotic investments for their wealthy clients?

Somewhere, we as an industry need to share the blame for such tough regulations as we have encouraged and endorsed many unhealthy practices (some still do) to gather AUM. Our own malpractices are now coming back to haunt us with such regulatory moves.

 A liquid fund has not been sold as an alternative to current account but as the best fund

 compared to that of the competition.

I also still have to understand the Maths of  Retail = Long Term = Equity

In a country, where more than 90% of financial savings are in fixed income products like Bank FDs, NSC Certificates, PPF, Kisan Vikas Patra and more, no attempt has been made by the industry or distributors to popularize fixed income funds to retail investors due to their poor margins.

Investor education fund was a great idea by the regulator, again not used to the full potential by our brethren. Instead of making the distinction between expenses of different plans available on account statements, it would have been better if the regulator had bought more entry barriers into who can act as an advisor or distributor. By ensuring a minimum qualification as to who can distribute mutual funds. Qualification may not always bring ethics, but in the least it will bring some responsibility to the role. Thus, AMCs, Distributors, Regulators are all collectively at fault for where we stand today.

We have done away with loads, high upfront payments which are all very healthy. It is only in India, that an investor investing Rs 5000 or 5 crores is charged the same expense. This does not still happen in USA, the most developed market. But, in the bargain of administering healthy practices, we are hurting the small time distributors the most who are the only one who can help get the true retail investor. The big wealth management firms and private bankers anyways do not care for a hard core retail investor. They are busy rubbing shoulders with the big and the wealthy. But a school teacher, an IT professional, a pharma co manager, these kind of people who really need help and need to be catered to will get alienated. There will be a risk of them being served more and more insurance policies over mutual funds.

Though, I would like to maintain that finding a right distributor or advisor is the biggest challenge. And how to identify one, has been covered Here

But the way things stand today! For any mis-selling after October of toxic investment products or insurance policies, can the distributor be solely blamed?

Disclosure : I am neither a distributor nor an advisor for Mutual Funds