Should Sebi reintroduce entry loads?

Most fund houses say that the industry is suffering ever since the entry load ban. To assess the industry’s health and open the debate wider, we analysed data provided by Amfi and Cams

Posted: Mon, May 14 2012. 1:10 AM IST
Kayezad E. Adajania

Ever since Hoshang Sinor, chief executive officer, Amfi, said in an interview to a newspaper in April that it’s time to review the entry load ban, there has been a lot of chatter in the Rs. 6.65 trillion Indian MF industry.

Removed by the capital markets regulator, Securities and Exchange Board of India (Sebi), in August 2009, entry loads were charges (up to 2.25%) that mutual funds (MFs) collected at the time of investment from you, the investor.

These charges were eventually passed on to the MF agent as commissions, which stopped after August 2009.

With few independent financial advisers (IFAs) coming together to form associations to better represent them in front of Sebi and the Association of Mutual Funds in India (Amfi), an industry body, a section of the MF industry is hopeful that they will be able to put more in the hands of their distributors through the reintroduction of entry loads. That U.K. Sinha—a former fund official himself, he headed UTI Asset Management Co. Ltd between 2005 and 2011 and was arguably one of the biggest critics to the entry load ban—heads Sebi further seems to fuel the hope of distributors and MFs. But should entry loads be brought back?

The MF industry is hopeful that Sebi may reintroduce entry loads because of three reasons. First, the industry claims MF folios have reduced, indicating that investors have moved out. Second, asset management companies (AMCs) aren’t making enough money and Fidelity Worldwide Investment’s sale of its Indian arm is being seen as some sort of endorsement to what they claim has made the MF industry unviable. And third, MFs claim that inflows have fallen, which means that investors simply aren’t investing in MFs, especially equity funds.

However, if you dig deeper into the numbers MFs and distributors are throwing at you, you’d see that perhaps the MF industry is not in as bad a shape as it looks or claims to be. We took data from Amfi and Computer Age Management Services Ltd (Cams; one of the two largest registrar and transfer agents) to assess the health of the MF industry—to look into the concerns of the MF industry and well, to open the debate wider.

Concern I

Money is not coming into MFs. Investors are staying away from MFs

Don’t forget: On the face of it, inflows have slowed. Compared with approximate inflows into equity-oriented schemes of Rs. 90,000 crore and Rs. 96,000 crore in FY06 and FY07, respectively, these schemes collected only Rs. 71,460 crore in FY11 and Rs. 53,886.6 crore in FY12.

Sinor says that despite entry loads being cut, investors are not rushing into MFs in droves. He says: “With cost to the investor having gone down, they should have taken the advantage. But they haven’t.”

Look closer. A bulk of inflows prior to 2008 came through scores of new fund offers (NFOs)—most of them mirrored the existing ones— that MFs launched. Rising equity markets and a favourable fee structure allowed NFOs to charge as much as 6% as initial issue expenses and then amortizing it over five years. Approximately 42%, 25% and 33% of total equity inflows in FY06, FY07 and FY08, respectively, came through NFOs. The NFOs have now considerably slowed down, even since Sebi banned amortization of NFO expenses in January 2008 and entry loads in August 2009.

“When entry loads were there, distributors used to nudge investors to churn a lot. That was the main reason why entry loads were abolished. These days, I am sure investors are holding their schemes for longer,” says Pune-based financial planner Veer Sardesai.

Concern II

The number of MF folios is going down; this means investors are redeeming

Don’t forget: Last year was bad for MFs. There were net redemptions (more money went out than came in) of Rs. 12,265.4 crore in FY11. But in FY12, equity funds saw a net inflow of Rs. 370.3 crore. This was despite folios going down by about Rs. 10 lakh between September 2011 and March 2012.

While fund houses say that poor sales or low commission have led to lower inflows, that may not be the only reason. Mumbai-based MF trainer Amit Trivedi points out that a lot of investors redeemed their money from closed-end funds that were launched between 2005 and 2007. “Though investors had the option to continue with those schemes after they became open-ended, not many did,” he adds. As part of his job, Trivedi travels across the country to give training to relationship managers of banks, fund houses and also IFAs on MFs.

He doesn’t have a good experience all the time, he says. “Once a 60-year-old IFA came to me and asked how to convince her clients to stay invested in MFs,” Trivedi recollects. Upon probing further, he found out that the IFA had “almost assured” MF investors to stay invested for just three years to get “good and positive returns”. “If the IFA does not even mutter the words ‘risky product’ while selling MFs s/he does not deserve to be a MF distributor,” says Trivedi.

This is also one reason why investors discontinued close to 1.66 million systematic investment plan (SIP) accounts in 2011, as per data provided by Cams and Karvy (two of India’s largest registrar and transfer agents) on the back of many equity funds showing negative SIP returns for a three-year period.

A small portion of the drop in folios is also because some of the top fund houses have started consolidating folios across the same investor-holding pattern (same first investor and same second investor and so on) woven by the same permanent account number (PAN).

“For instance, ICICI Prudential Asset Management Co. Ltd has been able to shrink folios by about 12% in the last four months,” said a person close to the fund house on condition of anonymity.

“The industry needs to stop worrying about these data points and needs to start focusing on ensuring that investors understand the advantages of investing in MFs. Most mutual fund CEOs are treating their asset management licences as asset gathering licences. And, hence the worry on the number of folios and the size of the flows. The industry needs to look within and start changing its attitude and approach towards investors,” says Ajit Dayal, director, Quantum Asset Management Co. Pvt. Ltd.

Concern III

Distributors’ income has gone down

Don’t forget: Sinor points out that till about a year or two back, there were 80,000 to 85,000 IFAs selling MFs. After Sebi introduced know-your-distributor (KYD) norms in 2010, only about 48,000 distributors complied with the KYD process. Agents, who are not compliant with KYD norms, will not get commissions.

According to Sinor, of about 15,000 active agents who are KYD-compliant, 202 earn an income in excess of Rs. 1 crore; one of the four criteria used by Amfi to shortlist MF agents across India whose commission income is now mandatorily disclosed on Amfi’s website. “If you remove institutions, then the number further drops to about 120. These are IFAs at an individual level,” says Sinor.

Jayachandran/MintSinor’s numbers are right. Mukesh Dedhia, a Mumbai-based MF distributor, claims he pays a monthly rent of Rs. 2 lakh for a 1,200 sq. ft office, apart from staff salaries and various other overhead expenses such as electricity and telephone. “Today when infrastructure costs have gone up, investments in capital markets have gone down, and so have our commissions,” says Dedhia.

IFAs, such as Dhruv Mehta who is the chairman of the recently started, Foundation of Independent Financial Advisors (Fifa), feels that the blame lies with banks and large distributors for encouraging churning that led Sebi to ban entry loads in the first place. He has a point. As per data provided by Cams, while banks saw net inflows of just Rs. 15 crore, IFAs saw net inflows of Rs. 1,318 crore between April 2011 and March 2012. Note that Cams services about 17 fund houses and represents about 75% of the MF industry in terms of the assets under management of its MFs.

Still, financial planners such as Sardesai as well as Trivedi feel that any rollback in entry loads might be “a step back”. Sinor, too, feels that bringing back entry loads may not be the solution “as it brings along with it, many ills, such as churning”. A section of the MF Industry feels that increasing the total expense ratio (TER) can be one solution. At present, equity funds can charge a maximum TER of 2.5% a year and debt funds can charge 2.25% a year. As the corpus grows, TER is supposed to come down. At present, most equity funds on average charge 1.75%. “TER limits can be increased and fungibility be allowed to give MFs the freedom to spend the way they like, staying within an overall limit. Of this, there can be a cap on upfront charges that MFs can pay to distributors. Over time, we can get the TER—and also this upfront cap—down, as the system settles down,” says the head of operations of a foreign fund house who did not want to be named.

Concern IV

MFs are not making money. Fidelity’s exit from India points to that

Don’t forget: With an accumulated loss of about Rs. 306 crore, Fidelity’s financial health was among the worst in the Indian MF industry, as per data provided by Value Research, an MF data tracking firm. Though its costs were high, market insiders say one of the biggest reasons behind its exit was Sebi’s diktat last year to all MFs to have their trading desks in India. Fidelity’s trading desk was in Hong Kong where it used to buy and sell its securities for all schemes, including those run by its foreign institutional investor and Indian MF arm.

Fidelity has denied though that this was the biggest reason. “No (that wasn’t one of the contributing factors), we respect Sebi’s policy change which applies to the entire industry and isn’t specific to us. This is a much broader issue. FIL has always recognized that to be successful and to do the best for our customers, our business operating model requires us to make full use of our scale and resources which are spread across the world. After many years of experience of running the India AMC, we have determined that this model does not fit well with the requirements of the Indian market. Consequently, we have concluded that FIL’s global operating model is holding back an excellent business which could otherwise offer the same high standards of service to an expanded client base,” its UK-based spokesperson had responded in an email we sent to them in April.

Apart from pointing out that top companies are making money, industry observers claim that one of the reasons why new firms are hesitant to enter the MF industry is because the industry appears to be “over-regulated”. “In the last two-three years, there has been a sense of unpredictability in the MF industry. Without a proper road map, regulations keep coming very often. No one wants to be in an over-regulated industry and Fidelity’s exit can be seen in this light,” says Srikanth Meenakshi, director,, a Chennai-based online MF platform. Meenakshi adds though that bringing back entry loads will be regressive.