Does anyone care about mutual fund investors?

From April 1, 2015, mutual funds have been asked not to give more than one per cent upfront commission to distributors for selling schemes to investors. This decision by the Association of Mutual Funds of India (AMFI) is intended to curb instances of exorbitant payments by mutual funds to distributors.

Market regulator Securities Exchange Board of India (Sebi) had raised concerns about high commissions being doled out to distributors. Indeed, distributors were receiving upfront commissions as high as 7-8 per cent on selling closed-end equity schemes to investors.

Of late, many mutual fund houses were coming out with closed-ended equity schemes to lure investors to the rising equity market. This helped them garner healthy assets under management (AUM). But this was not coming for free. Mutual funds were paying distributors hefty upfront commission, as high as 7 per cent on three-year closed-ended equity schemes.

AMFI's order doesn't cap the total expense ratio, or fees paid by investors to the fund, nor the total commission paid to distributors. It changes the pattern of payment a distributor would earn from  mutual funds. According to Sebi norms, a mutual fund could not charge more than 2.5 per cent as expense for a year. But mutual funds were still paying commission upfront to garner AUM and investors. This money was coming from the pocket of funds initially and later on they would recover it from the investors. Being closed-ended, investors could not move out of the fund for three-years.

But from April 1, 2015, irrespective of whether a fund is closed-ended or open-ended, mutual funds have been asked to not more pay than 1 per cent as upfront commission to distributors. The catch is there is no restriction on trail commission. While upfront commission is paid by AMCs to agents on the sale of a product, trail commission is paid by them through the life of a product to cover the cost of providing their services. Trail commission depends on the period for which the investor has stayed with the fund.
                                                                                                                                                                       
Does high commission equal mis-selling?

AMFI's new norm will not be a law so mutual funds are free to continue paying higher upfront commission. But they will be careful as everyone knows that this is a diktat from Sebi through AMFI.

But the more pertinent question is: Did  the regulator feel that distributors were mis-selling schemes? High upfront commission was paid largely in closed-ended funds. In February 2015, close-ended equity funds AUM stood at Rs 19,341 crore. It is about 1.6 per cent of the overall Rs 12.02 lakh crore AUM of the mutual fund industry. Also, closed-ended equity schemes accounted for just 5.6 per cent of the total equity AUM.

Indeed, while these are initial trends, closed-ended funds had started finding favour among investors as well as distributors. But the big mutual funds are worried about losing market share. Interestingly, some of the large funds had paid high upfront commissions in open-ended schemes funds in the past to capture market share. Today, it has become difficult for the big funds to sustain high growth rates and therefore, to maintain their market share and restrict the growth of smaller fund houses, they have come together to stop high upfront commissions.

If the big mutual funds feel paying high commission is mis-selling and is unfair, then why have they not  approached the Competition Commission of India (CCI) with a complaint? Indeed, rather than thinking about bringing retail investors into the equity market, the mutual fund industry is thinking about how to restrict growth of its peers.

Distributors are also to be blamed as they only sell schemes of the top fund houses and players that give them higher commission. They don't consider what is good for an investor. Rather than selling products according to the asset allocation requirement of the investors, they sell schemes which give them more money.

Its time distributors should be paid higher commission but the commissions should be on a trail basis. What this would do is the distributors will get more money to expand their business and bring in more investors into the mutual fund industry. While trail commission will ensure that investors are sticky with the mutual funds.

Meanwhile, some mutual funds, such as Peerless Fund Management, have already started paying trail commission to distributors. It means that if investors stay with the mutual fund for a few years, then the distributors earn much higher commission. Since October 2014, Peerless is only paying trail commission of 1.5 per cent per year to distributors. For instance in an open-ended scheme if the investors stays invested for four years then the distributors will earn 6 per cent, compared with 3.5 to 4 per cent in a scenario where funds pay upfront commission of 2 to 2.5 per cent and 0.5 per cent thereafter at the end of every year.

Today mutual funds are thinking of garnering more AUMs on the back of a rising equity market. In fact 2014/15 has been the best year in a decade for mutual funds who have managed to mop up more than Rs 62,500 crore as equity AUM. But distributors continue to remain short sighted and are thinking of pocketing immediate gains and squeeze more upfront commission. In the bargain, no one seems to care about investors who often feels cheated by the distributors for not selling products which will align with their financial goals.