Mutual Fund market has been growing tremendously in the last one decade despite being less well-known in India. What will be the effect of the new guidelines introduced by SEBI Recently? This article explores this and much more
Mutual funds are collective investment schemes that allow you to buy into a larger investment pool. As an investor you own a certain number of shares in your chosen mutual fund, which have the ability to rise and fall in price as the investment portfolio of your mutual fund matures. Mutual funds are a better option for investors because they are professionally managed and make the most of our cash by pooling it together with the assets of other investors.
Though this market may be slightly less well-known in India, it is rapidly growing in size and showing very high rates of growth and large financial profits. The top mutual funds in India have shown a huge amount of growth over the last few years, even outstripping their more established cousins in the United Kingdom and America in terms of the rate of growth. During 40 years of their existence, the mutual funds in India have witnessed dramatic pitfalls and a bumpy ride. In the last decade, the mutual fund industry has seen a tremendous growth, both quality wise and quantity wise. The number of mutual fund houses has increased with many foreign mutual funds setting up business in India and the industry has witnessed many mergers and acquisitions.
Emerging economies like India and China are experiencing a current boom that can give excellent returns on investment. You can choose a fund that runs out of the US or another developed country and invest in India, or a fund thatoperates in India. The Indian stock market would suit an investor with roughly a tenyear investment window. Mutual funds offer the security of diverse investments and the advantage of professional money management.
The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank of India. The history of mutual funds in India can be broadly divided into four distinct phases.
Unit Trust of India (UTI) was established in 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the regulatory and administrative control of the Reserve Bank of India.
1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990.
“Unit Trust of India (UTI) was established in 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India.”
With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed. The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993.
The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805crores.
In February 2003, following the repeal of the Unit Trust of India Act 1963, UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs.29,835crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit Trust of India, functioning under anadministrator and under the rules framed by Government of India and does not come under the purview of the Mutual Fund Regulations.
The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations. With the bifurcation of the erstwhile UTI which had in March 2000 more than Rs.76,000crores of assets under management and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking place among different private sector funds, the mutual fund industry has entered its current phase of consolidation and growth
Any changes which are proposed or carried out in the market should be with a long term view. Some proposals / reforms have very short life and may not benefit the investors in long run. At the outset, doing away of exit load sounds pleasing to ears and may get huge support from some section of investors. However, by the very structure of mutual funds, they are not supposed to be short term oriented products and to offer a reasonable return, the fund manager should have certainly as to the amount of investable funds he has. Though the exit load, which has been capped at 1% does not seem substantial, from the Behavioral Finance perspective, has a deterrent effect on short term withdrawal / redemption of funds leading to overall higher returns to the investors.
Another way out would be to explore the option of minimum lockin period; though it will take away the liquidity aspect of the mutual fund offering. Once again if all the information is provided to an investor in unambiguous and easily comprehensible manner, this should not be an issue.
On the issue of variable structure in MFs, I personally feel that it would be a great initiative. It once again brings me back to the same point of making the ‘Indian investing community mature and educated’. So long there is transparent disclosure of load chargeable and is understood by the investor and clearly communicated by the advisor, I see no issue with continuing with the current load structure. It cannot be discounted that some advisors do offer value added service and are responsible for leading to better investment returns and compensating them with higher fees should not be argued against; though setting up of upper limit (cap) seems justified.
In developed countries like the United States and the United Kingdom, the Funds could be broadly classified into three categories based on the loads – ‘Front-end load’, ‘Back-end load’ and ‘No-load options’. When buying a mutual fund with a Front-end load, the investor is required to pay an up-front commission whereas in the case of funds with the Back-end load, a fee is charged at the time of redemption. For No-load funds, they can generally be purchased or redeemed without a sales commission. We can also explore the option of moving towards a similar set up for funds and will bring the investing decision and choice in the hands of the investor without disrupting the mutual fund distribution market.
The market regulator Securities and Exchange Board of India (SEBI) recently said that “there shall be no entry load for schemes, existing or new”. This directive has forced the mutual funds industry to gear up for a new fee structure from August 1 2009. Investors will no longer be charged a 2.25 per cent distribution commission up front by mutual funds beginning. However, Fund houses would still be able to charge an exit load of one per cent when investors sell their investment. And fund houses would alsocompensate distributors through trail commission (a commission that depends upon the duration an investor stays in a scheme. This new rule is here to stay with SEBI ignoring the protests by distributors and the courts refusing to accept the pleas made by them. To avoid paying the entry load investors will have to invest directly with the Mutual Fund. Meanwhile, ICICI direct, one of the largest financial product distributors in India is the first one to revise its commissions on funds post SEBI’s directive, has announced that it has waived off transaction fees for its HNI (high networth individual) mutual funds customers.
As per the new fee structure, there will be no commissions for customers with cumulative MF investment of more than Rs 8 lakh. However, customers with cumulative investments of less than Rs 8 lakh will have to pay nominal fees of Rs 30 per SIP (Systematic investment Plan). The new guidelines would be applicable to all fresh investments whether in a new scheme or an existing one. In cases of an existing scheme, where the scheme has already parked funds in short-term deposits, the asset management companyhas been given three-month’s time to conform with the new guidelines.
The SEBI has also asked the trustees of a fund to ensure that no funds are parked by a scheme in short term deposit of a bank, which has invested in that particular scheme.
The SEBI guidelines say that asset management companies (AMCs) shall not be permitted to charge any investment and advisory fees for parking of funds in short-term deposits of banks in case of liquid and debt-oriented schemes.
It has also asked the trustees to disclose details of all such funds parked in shortterm deposits in half-yearly portfolio statements under a separate heading and has said that AMCs should also certify the same in its bi-monthly compliance test report. And all the short-term deposits by mutual funds should be held in the name of the scheme concerned only
In case the applicant proposing to take the control of the mutual fund is not an existing mutual fund registered with SEBI, it should apply for registration under SEBI (Mutual Funds) Regulations, 1996.
There are hundreds of equity funds in India. And more are being launched every week. And then there are the hundreds of debt funds, with many more being added every month. So, if you do not have the skill, the resources or even the time to build and track your mutual fund portfolio, then the investor is penny-wise and pound-foolish… Just to save the entry load of 2.25%, he will be risking 100% of his money! SEBI’s decision is in the investor interest but he should have the knowledge to benefit from it.
Once it becomes applicable, the investor has two choices : a) invest directly with the mutual funds, or b) go through a mutual fund advisor/distributor but pay for his services separately.
A wide variety of discussion is going on in various forums but mostly around the effectiveness. The new system is good from the investor point of view but not so for the fund houses. People will take time to reconcile to the new structure. The fund flow to the industry could get affected over the next three months.
There is a regulatory cap on expenses that a fund house can incur in a year. There is a cap on earnings. The fund houses can make money only by increasing volumes. But the new fee structure would affect the aggressive plans of fund houses to penetrate the market. Collections would now fall given that distributors would not have any incentive to sell mutual fund products. Initially there could be some problems but over a period of time, the industry would get adjusted to the new system. Each mutual fund will formulate its own strategy. It is a new system. It is investor-centric. All three stakeholders — distributors, fund houses and investors — will have to adjust to the new system
There is an estimated 1-lakh distributors pan-India, and according to AMFI, 85-90 per cent of the collection of the mutual fund industry is through distributors.
The practice of charging distribution commission has been in existence since more than a decade and the industry feelsthis has helped in considerably growing its business. The implications of the new rule are considerable as distributors will now not have any incentive to push mutual fund products and investors may not be inclined to pay distributors separately for advice.
Distributors are crying hoarse and their main grouse appears to be that:
Qualified and experienced professionals manage mutual funds. Generally, investors, by themselves, may have reasonable capability, but to assess a financial instrument, a professional analytical approach is required, in addition to access to research and information as well as time and methodology to make sound investment decisions and to keep monitoring them.
The investor is spared the time and effort of tracking investments, collecting income, etc. from various issuers, etc. It is possible to invest in small amounts as and when the investor has surplus funds to invest
Entry - Exit Load on Mutual Fund Products
Almost all products or services which are sold in India, carry a margin which is used to cover sales, marketing and promotion expenses. The same is true for the Mutual Fund Industry in India, which used to charge Investors 1-2.5% as entry/exit load to cover marketing and selling expenses including distributor’s/agent’s commissions.
However effective since August 1, 2009 Securities Exchange Board of India (SEBI) mandated that there shall be no entry load for all Mutual Fund schemes. This has led to a considerable impact on the business model of the Mutual Fund operators in India, as the dealers and distributors have shifted preference to sell products that offer better returns to them. India remains to be a country where people invest as per the recommendations of their brokers or advisers and the lack of such push has lead to the diversion of investment from Mutual Funds to alternative products. Agents often promoted funds that promised them the highest fee and persisting with the ban has resulted in heightened competition among distributors and have led them to look to promote other investments. While lower costs in terms of removal of entry load means lesser amount an investor needs to shell out, it means a lot especially to companies that are engaged in the Mutual Fund business alone. As per earlier regulations also the Mutual Funds could not have increased the load beyond the level mentioned in the offer document but since August 1, 2009 regulation has given a big jolt to many a Mutual Fund Company.
Often it has been debated as to how much regulation is necessary in India and whether a highly mature industry like Financial Services needs it at all. I am not saying that Investor protection should be compromised but companies should be allowed to run their business as per the models they consider best suited. After all, today is a market driven era and only the fittest will survive. So do we really need a regulation to control product’s modelling and pricing? India is at a crucial stage of development and we should send the right signals to the global world.
Prior to this declaration by SEBI, individual investors could invest directly in mutual funds. This implies that direct investment in such MF schemes is not dependant upon the coming into force of the circular that abolishes the ‘entry load’. SEBI probably banned the levying of an entry load since investors who were investing directly without the aid and advice of a distributor were being silently charged the entry load by the MFs anyway.
Close on the heels of abolishing entry load for mutual fund investment, SEBI has now asked fund houses to charge exit load uniformly for all classes of unit holders. The regulator has allowed fund houses to charge the exit load within the stipulated limit of 7% and without any discriminationto any specific group of investors. However, any change in the exit load at a later stage should not affect the existing unit holders adversely according to the prevailing guidelines. This has been done because the regulator has observed that fund houses are making distinction between unit holders by charging differential exit loads based on the amount of subscription. Higher amounts attracted lower exit loads and therefore this created an incentive to park higher amount of funds with asset management companies.
The mutual fund industry has been hit hard with the abolition of entry load and the subsequent regulation of exit load. After vehemently opposing the ban on entry fee on mutual fund investments by stock market regulator SEBI, the mutual fund industry has done a turnaround. In a meeting with the regulator, the industry has volunteered to bring down exit load tenures for most mutual fund schemes to one year. However, this reduction of exit load tenure is unlikely for few long term plans like the pension schemes offered by mutual funds that have a long term investment horizon.
The Flip side to the directive of SEBI also needs to be examined.
Though this shall provide higher quality of service and more transparency in market, now agents will have to deliver much better quality of service and be more transparent with investors This move will also force lots of mutual funds agents to shift their focus on ULIPS and similar products which have commissions linked with premium paid by customer rather than fees-based model like we now have in case of mutual funds. Mean more misselling in ULIPS on the cards, their bread and butter is directly linked with Investors and not Mutual funds companies.
Instead of introducing a variable load concept in isolation, this should be part of multiple share classes allowed from mutual funds. Variable load would be mutually agreed by investors and distributors and exit load and annual recurring expenses could be according to regulations. Another alternative could be that there would be no entry load and exit load, and annualrecurring expenses limit would be uniformly increased by 0.75 per cent across existing slabs. The present system of payment of commission has led to a lack of control by the investor over the quality of service vis-avis the commission being borne by him. This has led to a situation where advices rendered to the investors could be influenced by factors other than the investor’s interest. There appears to be a need to empower the investor in deciding the commission paid to the distributors and also to ensure transparency in commissions paid for mutual fund products.
The stock market is always going to be volatile. There are going to be bull runs and bear runs. Most investors in stock markets are illiterate. They act on tips and do not know how to select stocks to invest in. They buy stocks that are overpriced when the sentiment is good. During a bearish market, the sentiment is low and everybody is scared of the stock market and they sell. They end up losing in both cases. The market watchdog, the SEBI, is trying to help ordinary investors. It has gone on record to say that it’s working on the details of a variable mutual fund structure, triggering renewed hopes among investors that there will be no exit or entry loads when they invest in fund schemes in the future.
The regulator has offered a new proposal to check churning of MF schemes. The problem of the churning can be tackled only with effective legislation. The regulator needs to do a balancing act in this regard.
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