Mutual Fund: Splitting Advisor, Distributor Roles Should not Hurt Small Investors..!

Mutual Fund: Splitting Advisor, Distributor Roles Should not Hurt Small Investors..!

by NISHANTH VASUDEVAN, ET

There is anger, confusion and anxiety among a large section of the mutual fund distributor community.

The cause for this is a renewed attempt by the Securities and Exchange Board of India to split the role of an investment advisor and a distributor.

Simply put, a person, who advises a client on which scheme to buy, cannot take a fee from the mutual fund for selling its product.

Similarly, a distributor, accepting a fee from the fund, cannot recommend a client to buy a product.

If implemented, the move would be a game-changer in the way mutual funds are sold to investors, probably the biggest since the ban of entry load in 2009.

Currently, there’s no segregation in the role of a distributor and an advisor.

A distributor recommends a mutual fund scheme to an investor and receives commission from the asset management company.

The upfront and the subsequent commissions are deducted from the investor’s account by the mutual fund and paid to the distributor.

The thinking at the capital market regulator is that such an arrangement is prone to mis-selling to investors as the distributor gets paid for pushing a particular product. 

SEBI wants investors to increasingly invest on the basis of advice. In this arrangement, investors pay advisors a fee for a recommendation and invest directly in a mutual fund scheme (without going through a distributor).

In equity schemes, investing via direct plans could help investors save as much as 1% every year instead of going through regular plans.

SEBI has a point here: better fee and other incentives continue to be the driving factors for distributors, mainly banks, to sell a scheme to investors though the extent of mis-selling has moderated significantly since the ban on entry load an upfront fee of almost 6% that mutual funds deducted from investors’ money to pay distributors in 2009.

The entry load ban by SEBI, under the chairmanship of the indomitable CB Bhave, had sparked a furore with several distributors forced to shut shop, deprived of the rich commissions.

But, critics of the entry load ban today somewhere concede that this step had set the tone for making mutual funds one of the safest investment avenues in the country.

In contrast to earlier times when fixed deposits, real estate and gold were the assets of choice for investments, lakhs of investors are putting in their money in mutual funds these days.

Helped by a roaring bull market, of course, assets under management of the industry grew 30% from Rs. 16.46 lakh crore in December 2016 to Rs. 21. 37 lakh crore  a record in December 2017.

The distributor community too has benefited immensely from the flow of money into the mutual fund schemes.

So, it is only natural for distributors and even a section of the mutual fund industry to bear a grudge against SEBI for being a party pooper (this is the third discussion paper in the past two years proposing to split their roles).

There is no doubt that distributors will be squeezed as the concept of paid advisory services is yet to pick up in India.

But, the plan also needs to be seen from the context of investors. It has the potential to prune investors’ cost of buying mutual fund schemes as advisors will be flexible with their fees.

A mutual fund distributor-cum-advisor said this model will likely reduce the cost of buying an equity scheme by 0.4% to 0.6%.

Currently, the average total expense ratio of an equity scheme is roughly 2.5% every year. 

The biggest challenge, however, would be to handhold first-time and less savvy smaller investors, who could inadvertently end up paying both the advisor and the distributor for buying a mutual fund scheme. The rule should also not end up isolating smaller investors. This defeats the purpose.

As the Indian stock market and the mutual fund industry grows, generating alpha excessive return over the benchmark index will increasingly prove to be a challenge though such a scenario is still some time away.

Even if SEBI decides against going ahead with the plan to split the role of distributors and advisors, it will be beneficial to start looking at ways to trim the costs of investing in mutual funds.

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