On August 1, 2009, nearly a year back, the Securities
and Exchange Board of India (Sebi), the stock market regulator, banned mutual
funds from charging entry loads.
Mutual
funds used to typically charge an entry load of 2.25% of the net asset value of
a scheme and use that money to pay agent commissions.
In
the new regime Sebi wanted the agent and the investor to negotiate and arrive
at a commission, which the investor could pay the agent by issuing a separate
cheque.
At
least that was the plan.
While
this made it cheaper for retail investors to buy mutual funds, the fall in
commissions for its agents and distributors effectively left few people to sell
it to them.
Now
nearly one year on, the effects continue to be felt. “The situation is still difficult.
We are still seeing net redemptions,” said the head of a mid-sized mutual fund.
Assets
under management for equity funds, which have the most amount of retail
participation among the various segments have seen net redemptions in 8 out of
11 months since the ban on entry loads.
There
have been net outflows of Rs 8,160 crore since August 2009 in case of equity
mutual funds.
As
one industry person said, unlike other products such as toothpaste or toilet
paper nobody wakes up in the morning and feels a pressing need to buy a mutual
fund.
The Ulip conundrum
With insurance products offering higher commissions,
distributors are said to have dropped the mutual fund in lieu of a more
expensive investment product-the unit linked insurance plan, which is an
investment plan with a dash of insurance.
Ulips
have been paying significantly higher commissions than mutual funds over the
years, though structurally they are more or less the same.
Between
July 2009 and March 2010, for which the latest data was available, Ulips
managed to raise Rs 108,803 crore in total. That clearly illustrates the power
of commission in a country, which is gradually coming out of financial
illiteracy.
There
was an attempt to bring parity between Ulips and mutual funds when Sebi issued
a circular asking Ulips to register with Sebi, but an ordinance that placed
control definitively in the hands of the insurance regulator (Irda) and away
from the hands of the market regulator put paid to a glimmer of hope for mutual
funds.
Fund
houses grappling with changes are said to be finding it difficult to engage the
customer, said industry insiders.
“The
change was brought about too fast, business models need time to re-align. As a
result, engagement with end customer has gone down because everybody is focused
internally,” said the head of a foreign mutual fund.
What
also does not help is the fact that insurance companies are allowed to use
celebrities to advertise while mutual funds are not.
So
you have the likes of Sachin Tendulkar, Virender Sehwag and even super star
Amitabh Bachchan advertising insurance. “Now how do you expect us to take on a
me too product being advertised by Amitabh Bachchan, our superior performance
not withstanding?” asks the head of sales of a mid sized mutual fund.
Long-term Ulips?
Insurers have often stressed on the fact that Ulips are a
long term product. In fact that claim also falls flat in lieu of the fact that
over a period of five years, the average return of an equity mutual fund has
beaten the average return of equity oriented Ulips by more than 20%.
The
25 best mutual funds on the other hand have given an absolute return of more
than 80% in comparison to equity oriented Ulips.
Effective
competition is supposed to act in the best interest of the consumers. But that
does not seem to be happening in the context of the retail investor in India who can choose between the high
commission paying Ulips and very low commission paying mutual funds.
The
obvious reason as explained above is there are perverse incentives at work. But
the truth is a little more complicated than that.
Let’s
deviate a little into an interesting example that Sheena Iyengar gives in her
book The Art of Choosing about bottled water brands.
“The
two best-selling brands of bottled water in the U.S. are owned by Pepsi
(Aquafina) and Coke (Dasani), you’d be... unlikely to see them aggressively
advertising their health benefits relative to soft drinks, one of the few they
could legitimately make.”
The
moral of the story: A bottled water brand cannot say it is healthy to drink
water if it happens to be owned by a company which also sells soft drinks.
Similar
is the case with the Indian mutual fund industry. Not one mutual fund till date
has made an effort to communicate its better performance over Ulips in the last
five years. Not one mutual fund has made an effort to communicate its low
commissions vis a vis Ulips.
If
one side of the market cannot communicate what its strengths are then there is
no way a market can function efficiently and people of course will continue to
buy high commission paying Ulips.
And
why is that? The biggest Indian mutual funds are all promoted by companies
which have insurance subsidiaries. Be it Reliance, Birla, SBI, ICICI, HDFC,
Kotak, Religare Bharti Axa, ING, Tata, HSBC, Canara or LIC.
All
these promoters run both insurance companies as well mutual funds. So there is
no way any of the mutual funds can come out and compare their performance with
Ulips and say their performance is better. It is not in the interest of their
promoters.
Over
and above that some of these promoters also run banks.
And
for banks, insurance commissions are lucrative and an easy way of boosting
their other income.
In
fact a recent survey titled the “India Bancassurance Benchmarking Survey 2010”,
carried out by Rajagopalan Krishnamurthy of Towers Watson points out: “The
responses to the survey confirm the assessment that bank distribution in the
case of life insurance is currently highly skewed in favour of Ulips.
Ulip
sales account for more than 85% of premiums generated by banks.” And since
collecting these premiums pays high commissions, banks like to sell only Ulips.
So
basically it’s not in the interest of any of the players in the market to
disturb the current high commission paying set up. And you my dear investor are
the least of their considerations.
The regulator’s perspective
The chairman of Sebi, C B Bhave expressed the regulator’s
perspective at a mutual fund summit in June, saying that the regulator will
prefer to put the investor before the industry.
The
assets under management for the industry currently stands at Rs 6.75 lakh crore
with Income funds accounting for Rs 3.28 lakh crore. The huge amount of money
in income funds points out clearly to the oft repeated fact that the Indian
mutual fund industry caters primarily to institutional investors.
There have been other attempts by the regulator to make
the mutual fund more “retail investor” friendly.
Recently, Sebi has tried to bring in parity in the expenses
charged to institutional and retail investors. Large institutional clients
would be charged much lesser for their investments in debt funds compared
to retail clients. This, argued the regulator, amounts to the retail investor
subsidising the institutional one.
Fund
houses are said to have protested on the ground that the cost of servicing a
retail investor too, is different from that of an institutional client.
Sale of mutual funds through exchanges began after Sebi’s
November 13, 2009, circular stating that mutual fund schemes may be
permitted to be transacted through registered stock brokers of recognised stock
exchanges.
Despite
points of presence in-across India, the initiative has so far failed
to take off.On average, there have been 1,032 trades daily for the month of
July, less even than one for every one of the 1500 cities that just the
National Stock Exchange boasts a presence in.
A
number of other mutual funds are also reportedly looking for banking partners
to strengthen their distribution.
Some
in the mid-sized segment are looking at selling a stake including one that is
fond of gerunds and another which had tied up with a company known for its
telecom operations.
Consolidation
may not take place through acquisitions or mergers. “Consolidation in terms of
AUM could happen with more of the money going towards fewer of the players,”
said the head of one of the largest AMCs.
Meanwhile,
for many other mutual funds the ending does not seem as happy.
One
mutual fund chief executive officer summed it up, late one night, after the
passing of the ordinance which placed Ulips outside Sebi’s purview. “We are
dying.”
Moral of this story full of facts -
Number of distributors are interested to fill there pockets with
Investors hard earned money in the shape of commissions. And which is
not in the best interest of Investors. Investors should wake up now
& stop following the heard.
Make
your own investment decisions by opting a right professional. After all
one should not take a chance with there hard earned money.
Remember,
those who work in your best interest will always prove there ground
well before you become there clients. These people work on ethical &
honest grounds to help you out in your financial planning process.
