Mutual funds: Entry load might make a comeback as fund houses battle downturn

Sep 16 2013, 08:11 IST
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Mutual fund investors may again see a change in the way the industry charges them to keep themselves and the distribution community afloat. Mutual fund investors may again see a change in the way the industry charges them to keep themselves and the distribution community afloat.
SummaryThere's need to evolve better mechanisms to reward distributors and not burden new investors.

The mutual fund industry is pushing for the return of the entry load. Even as Sebi does not deny the possibility of reversing the ban, there is a need to evolve better mechanisms to reward distributors and not burden new investors with levies

Having already seen various models being designed by the regulator and market players to remunerate the distributors, the mutual fund investors may again see a change in the way the industry charges them to keep themselves and the distribution community afloat. Four years have passed since the Securities and Exchange Board of India (Sebi) banned entry load on mutual fund sales and while the industry continues to languish on the growth front ever since, the discussions to reintroduce the entry load refuse to die down. The regulator too seems to have kept its options open to bring it back in order to boost growth and penetration of mutual funds in the country.

Last week, while speaking at the Express Groups Idea Exchange in Mumbai, UK Sinha, chairman, Sebi, did accept that banning entry load was a mistake and it has affected the industry and its growth. Sinha, however, did not deny the possibility of a reversal of that decision.

I would wait for the investment climate to improve and watch for some more time before taking a call on the same, said Sinha when asked if the regulator is looking to bring back the entry load for mutual fund sales.

Till July 31, 2009, mutual funds could charge entry load. That meant distributors received a direct commission of up to 2.5 per cent from fund houses for all investments into equity funds and up to 1 per cent for investments into debt funds.

As the industry failed to grow after entry load was banned, Sebi, in August 2012, allowed mutual funds to charge an additional expense fee of 0.3 per cent if they manage to get at least 30 per cent of their total sales from beyond the top 15 cities.

Sinha is thinking on those lines even though he accepts that his decision to allow additional expense charge works out to be equal to that of the entry load that existed in the past. We have tried to rectify the same, said Sinha.

If entry load is one option that Sebi may explore to push growth within the industry, it is also looking to enforce mutual fund players to meet the criteria for sales in cities beyond the top 15.

Sinha said that the new mutual fund policy will have obligations for players to get business from beyond the top 15 cities and also hinted at actions against the non-serious players. Those who are non-serious players should not exist, said Sinha.

Did Sebi move have an impact?

The mutual fund industry had an asset under management of Rs 7,21,888 crore in July 2009. While the Sebis no entry load norm came into force beginning August 2009, the industry has over the last four years not moved any farther. As on August 2013, the average AUM for the industry stood at Rs 7,66,103 crore as on Aug 2013. In the same period the equity AUM has come down from Rs 1,68,783 crore to Rs 1,36,066 crore.

Sebis recent steps in August 2012 have failed to arrest investors outflow from the industry. While the AMFI data shows that in the period between October 2012 and March 2012 the equity oriented schemes witnessed a decline in folio numbers by 23.8 lakh, according to an insider the outflow continues and in the period between April 2013 and August 2013 almost 14 lakh folios have moved out.

Industry players, however, feel that the markets are undergoing a tough phase and the investor confidence is on a low, which is leading to their outflow. The environment has improved after Sebi announced measures to allow fungibility of expenses and mutual funds to charge additional 30 basis points as expense ratio for sales in cities other than the top 15 thereby pushing for inclusive growth, but the industry is shrinking, said the CEO of a small-sized mutual fund.

The murmurs in the industry

While the regulator tried to attract the distributor community towards mutual fund sales by way of introducing a transaction fee of up to Rs 150 in the past and then allowing them to charge an additional fee of 30 basis points as expense ratio, the moves have not had any notable impact and have also failed to rejuvenate distributors.

Almost 85 per cent of the industry sales happen in the top 15 cities and there is hardly an incentive for distributors in the major markets, said the CEO of a leading mutual fund on condition of anonymity. The fact that the industry has not grown even after measures taken by the regulator tells us that we need to think on other ways to oil the distribution system.

There are others who feel that in the current times the motto should be to over-communicate with the investor and the frequency of interaction with investors needs to go up.

The outflow of folios suggest that investor confidence is very low and in these times the last mile communication is critical. Both manufacturers and distributors will have to interact with investor because if an investor leaves the industry it is tough to get him back, said the CEO of another mutual fund adding that it is the time to be with the investor and reassure him of his investment decision.

Insiders say that the additional fee of 30 basis points will help the penetration of the mutual fund products beyond top cities and thereby is beneficial but they say that the majority of the benefit is to the large players who after crossing the threshold sales of 30 per cent beyond top 15 cities can claim the additional fee on their entire AUM.

The distributors in the top cities are getting nothing and even the smaller mutual fund players are at a disadvantage, said an industry insider who did not wish to be named. While the entry load may not be the solution, a method needs to be framed that ensures everyone is nurtured.

What it means for you?

Under the existing rules, even if you are an old investor, if the AMC manages a revenue of 30 per cent from cities beyond the top 15, you will see fund houses deducting an additional expense charge of 30 basis points from your investment and thus putting a burden upon you.

Consider this: If you invest Rs 1 lakh every year for 20 years and the investment grows at 10 per cent per annum. At an expense ratio of 2 per cent your total outgo stands at Rs 8.6 lakh over the 20 years but at an expense ratio of 2.3 per cent it will jump to Rs 9.9 lakh. Thus the burden of this additional expense ratio of 30 basis points is not a few thousands but Rs 1.3 lakh over the tenure of investment and you will be charged this even if your investment is an old one.

However, if Sebi had introduced an entry load of 1 per cent then that would have gone only on the investment amount and it wont impact old investments. Further it would have gone to the distributors directly rather than benefiting large manufacturers. Also in this case, old investors wont be subsidising the new investors.

While the manufacturers and distributors have learnt to live in the no entry load regime, it may not be necessary to bring back the entry load and put additional burden on new investors. However there is certainly a need to redesign the manner in which the distribution community is remunerated.

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