In the existing market structure, the mutual funds market has a plethora of people engaged in doing essentially the same work which is to bring more investors into the market. These people may call themselves Mutual Fund Distributors, Independent Financial Advisors, Financial Consultants or Investment Advisors. They not only sell the mutual funds to their clients but also advise them over which fund to buy. Their earnings come from two routes. One, charging a fee from their clients and two, commission received from mutual fund houses which can come in as either upfront commissions or trail commissions.
An upfront commission is paid on the sale of the mutual fund and trail commission is paid according to the period the customer chooses to hold the mutual fund.
This structure of commissions brings in anelement of bias in the advice given by the distributors.They usually push the clients for a fund that provides them with better upfront commissions.Once the investor finds that the fund is not performing as well as they expected, distributors convince them to invest in another fund. Since the trail commissions are usually lower than the upfront commissions offered, the distributors earn more from short term investments than from a long-term investment by their client.
SEBI has proposed a regulation to separate the mutual fund distributors from advisors. The aim of the regulator is to remove the conflict of interest which found its place due to the commission structure of the advisors/distributors.
Now with the new regulations the advisors will charge a fee for their advisory services without considering what commissions are being offered. They will not be allowed to sell any funds to the client. The MFDs (Mutual Fund Distributors) will be restricted to only describing what the mutual fund offers and provide execution services/selling mutual funds.
This reduces the amount of commissions generated by the MFDs. MFDs have acted as the major player for bringing investments to the fund houses from B15 cities. If the commissions of distributors are taken away then the investments by B15 cities and to an extent even from T15 cities will fall. Some of the mutual fund distributors will leave their occupation and look for other jobs. Others will find loopholes in the new regulations and continue earning the same while sacrificing their fiduciary responsibility. And still others would surrender to the stricter regulation and settle for lesser earnings.
A survey by InterMedia- Financial Inclusion Insights Survey, Wave 3 (2015) points out that majority of Indian investors take advice from their spouse, family, relatives, friends and neighbours. Table 1 below shows, in decreasing order the percentage vis a vis the people who are consulted for financial advice. Not even 5% of the people approach advisors. People in India are not yet ready or willing to pay for financial advisory services. It is evident that segregating the activity of selling and advising will only leave people bereft of any advice. If SEBI wishes to improve the current regulatory system, it needs to include the behaviour and psychology of people, that dominates their actions while investing.
|What or who do you depend the most for a financial advice|
|Friends, family, and neighbours||25.1%|
|Informal saving/lending groups||0.2%|
Source: Financial Inclusion Insights Survey, Wave 3 ( 2015 )
Instead of going forward with the current proposal, SEBI could pass a regulation to equalise the upfront commissions offered by all fund houses. This would remove the root cause of conflict of interest between the distributor and the client. The mutual fund distributor would not get additional benefit from promoting any particular scheme over the other. Instead the distributor will most likely put money of the client into a fund which would generate the best returns and thus the client would like to hold it for long. This would increase the earnings of distributors through perpetual trail commissions. Investors would save on exit load as they won’t have to change funds every few months and would also see a rise in their incomes by investing in the best funds in the first place. The market would also become transparent and devoid of bias.