Will fund penetration improve?

The basic idea behind the current move is to enhance mutual fund penetration by increasing points of presence (POPs). But the haste displayed in implementing the scheme has left a lot of loose ends. So far only UTI Mutual Fund has listed its schemes on the National Stock Exchange (NSE). No one is really sure how long it will be before the schemes of all the other fund houses become available.

Further,it is not clear how much transaction fee brokers will charge for buying and selling mutual fund units. Selling mutual fund units was free so far,so it would be a step backward if investors have to pay for this now.

Besides,very few terminal operators may be currently eligible to buy and sell mutual funds on behalf of clients. Passing the Association of Mutual Funds in India (AMFI) test for mutual fund advisors is the qualifying criteria. The number of stockbrokers who have passed this test is quite small.

Customers unwilling to pay for advice

Another question that begs an answer is whether this move will provide an ecosystem wherein investors get the right advice. In the past,mutual fund distributors’ advice was biased due to the commissions they earned from selling a particular type of funds (new fund offers or NFOs) or churning clients’ portfolios gratuitously. One is not sure if the answer to this question is now in the positive.

If I have understood anything from Rama Bijapurkar’s book We are like that only,it is that the Indian customer is unlike any other. Sebi is trying to cultivate an advisory model,but customers are not yet prepared to pay a fee for advice,and may not be so for a long time to come. Had they been ready,the no-load investments in mutual funds in combination with paid advice would have taken off by now.

So if investors will not pay financial planners for advice,how will they decide which mutual funds to invest in? The same way they decide how to buy stocks — with “free” tips from friends,colleagues,brokers,etc. A few good brokers with good research teams do provide good advice on stock selection,but hardly any of them is able to charge for the advice,except by way of charging a transaction fee,which they are anyway entitled to,advice or no advice. When the only way the advisor can make money is by transacting,there is always the fear that portfolios will be churned. This was the trouble with the fund industry in the first place. So Sebi might just end up replacing one devil (the mutual fund distributor) with another (the stock broker). Stock brokers already have a reputation for churning their clients’ portfolios. Witness the percentage of shares for which delivery is taken vis-a-vis the total number of stocks traded on the exchanges,which doesn’t even touch double digits.

Needed,greater financial literacy

Currently about 5 per cent of the country’s gross domestic savings is invested in equities. This is despite the government offering incentives for investing in equities by allowing zero tax on long-term capital gains. When 90 per cent of the country’s investors are not aware of or onvinced about the merits of equity investing,the mere availability of mutual funds on stock exchanges will not lead to more investors buying mutual funds. Hence the need to promote greater financial literacy.

The way out

With the entry load having been done away with,mutual fund advisors and distributors have become reluctant to service small clients. At present all they earn is a 0.50 per cent annual trail commission on the value of their clients’ corpus that they get from the fund house. When the investment is small,this is not sufficient incentive for them to sell mutual funds. More of them are likely to gravitate toward selling insurance,where the commissions are higher,but which are more expensive products (moreover they are not primarily investment products). A balance needs to be struck between keeping the costs of mutual funds low and offering adequate incentives to mutual fund distributors.

The Indian customer is not averse to the broker or advisor making a reasonable amount of money from his vocation,as long as he,the customer,does not have to write a separate cheque for him. Sebi must henceforth watch the situation closely. If the current regime results in a high amount of churning,or if existing mutual fund advisors and distributors shy away from the business,Sebi should not be dogmatic. It should not hesitate to return to a regime where it lets the broker/advisor earn a slightly higher fee (than the current 0.50 per cent) on the total assets of his clients. This fee could be built in the fund management fee being charged by the asset management company and paid to the broker. In such a regime,both the stock exchange brokers and existing mutual fund brokers would be at par (stockbrokers would also not charge a transaction fee but only depend on the commissions paid by the fund house). The investor would thus have multiple options to invest. Only if the remuneration for being a mutual fund advisor is decent will the existing advisors continue to sell funds and fresh talent will enter the business — which is very much needed for mutual funds to acquire greater penetration. And only then will that paltry figure of 5 per cent (of gross domestic savings going into equities) turn into a more respectable number.

The author is a certified financial planner and director of Wealth Gyan. jaideeplunial@wealthgyan.com