SEBI capping Mutual Fund expenses

One wonders why financial services industry needs to be pushed by regulatory bodies to act in investor’s interests.

In the Board meeting y’day, SEBI knocked off a few percentage points from the expenses charged by Mutual Funds:

The Assets Under Management (AUM) of mutual fund industry in India has grown manifold over the years. As on August 31, 2018, the AUM of the industry has crossed INR 25 lakh crore. While the AUM has grown multiple times, the benefit of economies of scale has not been fully shared with the investors. Further, the slab wise limits of TER introduced in 1996 under SEBI (Mutual Funds) Regulations, 1996 have not been changed since then. It is also observed that over a period of time, there have been varying practices in the industry with respect to charging of expenses and payment of commissions.

SEBI undertook an internal study to review the TER. The analysis along with observations of the study was placed in a meeting of the Mutual Fund Advisory Committee (MFAC). The working group constituted by MFAC deliberated on the issues and submitted a report to MFAC. Upon deliberation on the findings of working group, MFAC made several recommendations on transparency in expenses, TER for various types of mutual fund schemes, investments through SIPs, limiting the additional incentives for B – 30 cities based on inflows from retail investors, performance disclosure of Mutual Fund schemes, etc.

The Board took note of the benefits of the proposal with respect to sharing of economies of scale, lowering the cost for mutual fund investors, bringing in transparency in appropriation of expenses, and reducing mis- selling and churning. 

The expenses have not just been slashed but the big funds will be required to charge a lower TER. The TERs are higher for quity funds vis a vis debt funds. Likewise TERs are mentioned seperately for closed end funds, index funds and fund of funds. It has allowed addiitonal TER of 30 bps for selling to B-30 cities.

More importantly, commissions shall now be based on trails. VR explains:

While SEBI has also reduced the expenses that funds companies can charge from investors, the big change is that it has outlawed the upfront commissions that fund distributors get for getting investors to put money into a fund. Instead, they will only get what is called ‘trail’ commission. ‘Trail’ means a steady, small percentage that the distributor gets as long as the money stays invested.

This is actually a very big deal. The reason is that while it appears to be superficially about commissions, it’s actually an attempt at triggering a deep change in distributors and fund companies’ business model so that their economic interest aligns with that of the investors. An upfront commission means that whenever an investor makes an investment, the distributor who facilitated it gets perhaps one to two per cent of that amount. This means that the distributor’s interest lies in getting a transaction done. To make more commission out of a given customer, the best strategy is to keep moving the money and creating more transactions.

Now, SEBI has outlawed upfront commissions. Distributors can only be paid trail commissions. There will not be any incentive for switching money around for the heck of it. As long as the investor is invested, the distributor gets a steady stream of revenue. That’s it. It sounds simple, and in terms of the benefit that brings to the investors, it is. However, over the years, I have observed that in many fund companies and in distributors, there is a deep culture of hard-driving sales teams out to get as many transactions done as possible. That should change now, even if gradually.

Earlier, the name of the game was to move the money by whatever means possible. Now, it will be to get the money into a set of good funds where the investor will be happy to stay for a long time to come. Not only will sales need a different approach, it will need a different approach to business, even a different kind of person.



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