Does New SEBI Circular Really Help Mutual Fund Investors?

 Does New SEBI Circular Really Help Mutual Fund Investors?

by Ms. UMA SHASHIKANT, Centre for Investment Education and Learning

There is one segment in the financial market which works on the premise that investors need a diversified portfolio of market securities that professionals build and manage for a reasonable annual fee.

This segment--the mutual fund industry-is very competitive, transparent, efficient and clever. It, however, consistently gets rapped on the knee for one thing or / the other.

The latest is the SEBI circular that asks for more disclosures. Who will this help or harm?

In most regimes worldwide, with the sad exception of India, mutual funds manage large corpuses of pension and insurance pools. The Indian mutual fund industry has been bogged down for many years by a singular problem- lack of size.

There are at least three reasons for this. First, many investors find the idea of investing in the markets rather complex.

It takes time, effort, education, and experience to figure out that funds make immense investment sense for long-term investors.

Second, funds focus on selling to achieve size, so that the fixed costs of employees, infrastructure and technology can be leveraged. To sell is to push, to portray products in a favourable light, to persuade and persist, and to be opportunistic. Not traits that endear them to the investor or policy makers.

Third, mutual funds do not have reach. Their cost structure makes it unviable to have too many branches and employees.The market for distribution is skewed against them. It is far easier to sell insurance products and earn much more as commission.

Mutual fund distribution is a mixed but shrinking bag of good, bad and ugly players, who struggle to differentiate themselves.

The regulatory approach to the mutual fund business has rightly been that investors should be protected from clever sellers who push unsuitable products for a commission.

The regulatory response to this global problem has been to ask that the investors pay the commissions instead. This is easier said than done. Mutual funds were also mandated to introduce direct plans which enable investors to buy a product without paying any distribution charges.

The SEBI circular of March 18, 2018 simply extends this idea further.It has asked that the bi-annual account statements that investors receive show the cost incurred on distribution.

They should also disclose the cost structure of the direct plan, so that the investor is able to compare and choose. The benevolent view is that investors would choose the direct plan and pay the intermediary directly , using the differential as a benchmark.However, there are many flaws in this assumption.

First, investors would now know how much their distributor is earning. The clever ones would ask for a direct or indirect pass back.

Second, inferior distributors would grow insecure about this disclosure and would be willing to forego a part of it to keep the investor happy , creating an undesirable spiral to the bottom when it comes to distributor earnings.

Third, quality distributors will struggle to differentiate themselves and negotiate a fee from the investor that matches the loss of commission.The net effect would be a reduction in income for distributors .Many distributors will face a fresh round of uncertainty .

It is a long-standing demand that the distributor who is a mere seller, and the adviser who works in the client's interest, be differentiated. While everyone agrees that this would be in the best interest of the investor, industry and intermediaries, making it happen on the ground has been a challenge.

SEBI notified the Investment Advisers Regulation in 2013, but the struggle is that a distributor has to give up the sizeable annual commission income built up over the years, to become an adviser who will depend on the unreliable fee income that an investor may or / may not pay. Less than 400 advisers have found it worthwhile to register.

Which of the problems we just discussed does this new regulatory mandate solve? Fear of lower and falling commission income means even fewer distributors will go out there in search of business and talk about mutual funds. Investors may choose a direct plan, and know what they have saved.

Funds will continue to struggle with volumes and reach and wonder about the next big idea to mobilise money .

The solution may be simpler, if the regulator concedes that the annual trail commission rightfully belongs to the adviser who holds expertise, registers and complies with regulation, and wears the badge of investor interest.

The writer Ms. UMA SHASHIKANT is managing director , Centre for Investment Education and Learning

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