Indian Mutual Fund Industry
12:06 AM
| Indian Mutual Fund Industry : Winds of Change By announcing the setting up of trading platform for mutual fund units in the exchanges, Sebi has automatically opened the mutual fund window to millions of potential investors from the rural and semi-urban areas. This is an indication that the investors are all set to rule in the fast-growing mutual fund industry. A very recent circular issued by the Sebi created big news in the mutual fund circles. In another paradigm shift, Sebi announced a dedicated trading platform for the mutual fund products on the major stock exchanges. The din that was created in the distributor and advisor circles after the announcement of the ban on entry load (a charge levied while selling mutual fund products) a few months back had not settled down completely, when the above new announcement hit the mutual fund industry. The writing is on the wall for the intermediaries in the mutual fund industry. Shape up or ship out. Even the fund houses got a clear message. Reorient policies for investor benefit. It is evident that investors are set to rule. The beginning Before examining the two big recent events, along with many other investor-friendly initiatives of the regulator, that have shaken many in the mutual fund industry, let us peruse the issue from scratch. In the last 18 months, Sebi made news on several occasions when they released as many as 22 circulars with a strike rate of more than one a month (may be a record), touching almost every issue of the mutual fund business and possibly hitting every participant of the industry barring one, `the investor'. The given Table highlights the major circulars issued by Sebi to the mutual fund industry. The pace and intent are clearly visible. The number of circulars, the wide coverage of various facets of mutual fund business and micro management of certain issues clearly spell the depth of importance given by Sebi. As it is seen, it involves everyone who is associated with this industry. The genesis of the current new `investor-friendly avatar' dates back to a period prior to October 2008, when things were moving fast in the mutual fund industry. The pace was visible and felt. The Assets Under Management (AUM) growth was phenomenal then. The number of new entrants evincing interest in this industry was encouraging. The new fund offers were pushed at great speed towards investors. Several varieties of existing products were offered. Above all, one community was smiling all the way with roaring business. That was the `distributor or advisor' fraternity, a vital intermediary in the mutual fund setup. Things were smooth when the first jolt was felt around the October 2008 liquidity crisis. In order to overcome the crisis, when redemptions were pressed by some large entities on or ahead of schedule, leaving small investors' interest highly risky, Sebi must have got the first wake up call for a major overhauling. Since then Sebi has not looked back. While many other micro events might have equally convinced Sebi towards the new thrust to protect investors, October's was possibly the trigger. The pace shifted to the regulator side, and since then there was no looking back. Who is the loser? Will investors truly benefit? Are we going to see the same growth in the industry? How is the landscape likely to change in the future? These are some of the questions we must answer. We discuss the two major salvos of Sebi first, before trying to answer the questions and predict the future scenario.  Entry load The first major salvo of Sebi was to scrap the entry load with effect from August 1, 2009. Entry loads are upfront payments from investor's pocket along with his investment in a specific mutual fund scheme. The entry load paid is passed as commission to the distributor/ agent, either wholly or partly or by supplementing further amount, by the Asset Management Company (AMC) for the service rendered by him in collecting the payment. By scrapping this, Sebi empowered the investors in deciding the commission paid to distributors. Before this, the distributors earned a fixed sum on mutual funds irrespective of performance. Those were times, when investor investments were more through inducement than knowledge. This led to constant churning across schemes and hampered long-term asset creation, which might have forced Sebi to issue this diktat. While some other reasons might have equally prevailed, this one appears to be the most important one. The effect is that it has already altered the dynamics of the mutual fund industry. The impact has already started showing in the AUM of the mutual funds. The AMCs have begun to reorient their strategies. More time is spent in marketing existing funds than the new ones. Some have diverted the resources to other avenues like PMS etc. to keep the net revenue intact. The distributors, who by far have made the maximum noise, have come to terms with the new environment and have initiated steps to augment infrastructure, knowledge, systems, etc. to earn rightfully. In the new scheme of things, the distributors now prefer to push alternative products, especially the high incentive insurance products. For survival, many distributors have now offered to provide several services across various financial products. Voluntary service from distributors and advisors to sell mutual funds has virtually stopped. The investors who got used to the `perceived' free service are shying away from paying, even if they are offered genuine service. The `rich' AMCs have devised new methods to pay the distributors, albeit lower than before, by dipping into their coffers, and aim to continue to collect funds the inducement way. The new process may not last long. This increased expense, lack of organized distribution channels, and decline in profitability may force reconsideration and may also force some smaller fund houses to quit the business and could result in industry consolidation. However, ultimately it is the good fund performance that would rule the market. Automatic inflows would be seen only when the investor becomes knowledgeable, and he understands that quality service needs to be paid and it is the good performance that is going to augment his wealth. We know that money chases better returns. Obviously, this fact would force investors sooner or later to shift money to better performing funds. Investor education is important here. It is a challenge for everyone, including the regulator. Investor education is the joint responsibility of all fund houses, Association of Mutual Funds of India (AMFI) and the regulator, and in fact of the government and every entity who believes that mutual fund industry growth is an important requirement for the overall healthy investment setup. MF products on stock exchanges In what we can as a second salvo, the regulator Sebi, in its most recent and landmark announcement, pronounced the creation of separate mutual fund trading platform on the stock exchanges. It has opened a new transaction point for the investor. This one being the easiest way of buying and selling mutual fund units, which can be done over phone. Units purchased or sold will be credited or debited to the investor's dematerialized account, just like the way the shares are traded today; with similar convenience, even redemptions can be pressed. Obviously, the required formalities are to be completed. This means an investor can have just one consolidated demat account showing all his mutual fund holdings and equities as well. At present, liquid funds and systematic investment plans are not available on stock exchanges. The broker needs to be certified by the AMFI and has to apply for the trading platform. The numbers of Indian cities where one can buy and sell MFs would go up straightaway to about 1,500, up from about 300. Possibly, Sebi did not want to wait for mutual funds to take the initiative of setting up offices in the Indian hinterlands. Alternately, it can be viewed as Sebi wanting to signal financial inclusion. For the mutual fund, this is an opportunity to tap a new source of inflow. It is the mutual fund house that would be the biggest beneficiary if it clicks the way Sebi thinks. An MF would save on the cost of printing and dispatch of account statements if the transaction is done on a stock exchange. The same goes for printing application forms. Now, under a new setup, since one can place an order to buy or redeem units over the phone, there is no need to fill any forms. The savings would amount to crores of rupees, with the amount significantly large for the biggies. This amount can be spent productively towards investor education or for other productive avenues. The decision might be another blow for the mutual fund distributors and Individual Financial Advisor (IFA) who are already struggling with the no entry load norms, especially the ones who do not have enough infrastructure or those who have nil infrastructure. The weak ones are set to perish and only the fittest and the efficient will survive. Interestingly, the stock broking fraternity might see mutual fund distribution as a new line of business. It could also give brokers a different profile of potential customers for their business. A big advantage for a stockbroker would be the advantage of directly being able to debit the client's accounts, much like the banks, which a normal MF distributor was not having. Going forward, this would lure distributor- broker tieups owing to the presence of tremendous synergies for both. It is feared that what Sebi has taken away from the distributors, it has returned to the brokers. In the earlier era, most distributors were pushing products for commissions and promoted churning. Now it is felt that the brokers would do no different job because brokers are not expected to give an expert advisory call. Therefore, the tendency of investors to trade without knowledge would still remain in the new era. In fact, now it would be a convenient world for investors with a wider reach. Another issue that might be open for discussion is the brokerage that would be charged by the broker when an investor transacts a buy/sell/both in the exchange trading platform. Unless brokers charge a lower rate for MF schemes as compared with direct equity, an investor would not be much interested in transacting through the exchange. Also, any grievance at the brokers' end is a new problem for the investor. Add to this, the cost of advice that the broker would charge. The overall cost would be higher, as the opportunity cost of time for a broker is much higher as he is already very much engaged in his business and requires him to take the mutual fund business seriously enough to invest time and effort. Another fear is that MF units would be treated like stocks by investors. If stock-like activity is seen, then AUM volatility is likely to be high. And fluctuating AUM is not good for fund management and frequent buying and selling increases transaction costs and affects returns. Other issues In the changed setup, post-entry load ban, many investors were put to great discomfort whenever they wanted to switch investments from an AMC to the other. Investors were required to get an NOC (No Objection Certificate) from the old distributor, in case he decided to change the distributor or were to apply directly at AMC. This created lot of hardships to investors. The old distributors avoided issue of NOC because they would be losing the trail commission once the investor switches to another distributor. Post-entry load ban, giving away even the trail is simply going broke for many. This required the intermediation of the regulator. Sebi in its most recent circular has sent a terse warning to entities concerned to desist from insisting on NOCs. Among other measures, Sebi has directed asset management companies to have a systems audit conducted by an independent CISA/CISM auditor at least once in two years. The asset management activity is mostly technology-driven and hence the requirement of the audit. This systems audit report and compliance status should be placed before trustees of the mutual fund and that the report/findings along with trustees' comments should be communicated to Sebi. Audit of the entire system ranging from front office, back office, fund accounting, financial accounting and its integration would be done. Sebi has also announced exit load rules, which bars mutual funds from having different exit load structures for various classes of investors. This measure is definitely aimed at helping small investors. Certain AMCs deliberately kept lower exit load for big investors. This was affecting returns of small investors. Sebi also introduced norms on valuation of debt securities, simplification of offer documents and Key Information Memorandum (KIM), etc. which all are investor-friendly. Future prospects So many changes so fast might be the first remarks of anyone who is associated with the industry. But if one understands the underlying notion, it would be evident that the changes have happened with a clear thought process. For instance, with the announcement of the setting up of trading platform for mutual fund units in the exchanges, Sebi has automatically opened the mutual fund window to millions of potential investors from the rural and semi-urban areas. With the entry load ban, Sebi has helped investors save cost and enhance returns. When Sebi imposed entry load ban, distributors chased higher commission and suddenly switched to marketing insurance products. It automatically implies that all these days distributors sold mutual fund products with sole financial objective. In India, investors listen to the distributors and inducement way of selling prevails. Investor education is the only cure. Going forward, investor education initiatives would therefore increase, and investors in future are likely to make more informed investment decisions. Investor expectation would change from chasing highest returns to sensible investment planning. Only knowledgeable financial planners would survive in future. Investors would start gauging the performance based on risk. Therefore in future, risk adjusted returns would be the benchmark of performance in investors' eyes. Understanding of products would automatically improve with investor education. Investor meetings would be more frequent for a fund marketing personnel. Brand building in the MF industry would gain prominence. And it is brands that would forge stronger relationships with investors. Mobile, Internet and possibly television would become dominant platforms for information and trading. The new environment would see more consolidation in the mutual fund industry. The one who would invest in their brands, people and technology would survive. Cost reduction along with investor education would be assigned top priority. Services will be top notch and for that to happen best technology would be invested upon. Sooner or later, an investor would be able to buy and sell mutual fund units using his mobile phone. As such, the initiative has already begun with the listing of mutual funds on stock exchanges. The future of mutual funds in India is very bright, though it has paused owing to the structural change that is underway. If one believes that the goal of `financial inclusion' would be met realistically, tremendous expansion of the industry can be visualized. Some may complain about the pace of change during the last one year, but the new environment is here to stay, foremost to protect investor interest than any other one thing. The regulator would play its part, ensure effective MF governance. Every initiative of Sebi is towards empowering the investor. Investors are henceforth set to rule in the fast-growing mutual fund industry. |
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