Investment in stocks has its share of risk. When I participate in the market, what is the sensible way to reduce my risk? Do good research and have a diversified portfolio. Both these need some amount of time and resources to commit. So investing in mutual funds is the next best option for me.
I know for the benefit of diversification, expertise in fund management and diversification of portfolio the AMC offers me I need to pay a price. So the funds are allowed to charge a certain management fee.
But then there is charge that the funds take from me that they call the entry load which is in the vicinity of about 2%. A good part of this goes as the commission to the distributor. I, as the investor, have no right to decide what I pay the distributor who helps me to make this investment. But when I invest in the stocks directly I can decide what I want to pay my broker. Today he charges me a very small fee of 35 to 50 basis points compared to almost 200 basis points that the fund distributor charges. In addition, the distributor gets to share a part of my return every year as the trail commission. (The rumor in the market is that sometimes these commissions get shared by some decision makers). I feel that the total effort that the broker spends on me when I buy shares in the market is much more than the effort that the fund distributor spends on me even though the ticket size of each of my transaction is much larger when I invest in funds.
The question that SEBI has now asked the AMC is precisely this. Why shouldn’t the brokerage for my distributor be decided by me? In addition it reduces the incentive that the distributor has to make me switch in and out of the funds more often. Further when the incentive to the distributor is paid for by the fund house he is not my advisor who looks after my interest; his loyalties will naturally lie with the fund house. Sometimes the poorly managed funds are able to get my investment because they have been able to influence the distributor with a more lucrative incentive.
Surprisingly it is not just SEBI who is asking question. The regulators in UK and Australia are also thinking along similar lines. In fact SEBI has advised that the new charge structure should be in place from August 2009.
The fund houses are not amused. It reduces the leverage they had with the distributors. Naturally they point out that the incentive structure is more skewed in the insurance industry where many of the insurance products are more of fund management solutions and less of insurance. But SEBI can regulate only the mutual funds. They cannot wait for the whole world to clean up before they clean their backyard. Can they?
It makes enormous sense for the investor; but not for the fund house.
It is true that the investor had to pay the mutual fund broker a commission for his services earlier. However SEBI had earlier given an option to investor to apply directly to the Mutual Fund, whereby no entry load will be charged on those applications. Now SBI has repealed the entry load since 1st August 2009, many mutual funds have altered their exit load structure, which is affecting the retail investors. The regulators should look at this anomaly of differential exit load for retail and institutional investors. Otherwise the retail investors are getting a biased treatment for investing their funds with mutual funds.
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