Three days ago, SEBI chief M. Damodaran initiated one of the most significant acts of reform in the country's mutual fund industry for a long time. The market regulator wants the 'load' that is deducted from mutual fund investments to be abolished for those investments that are made directly with fund companies instead of being done through fund distributor. This reform has produced a great deal of alarm among fund distributors and probably fund companies but in my opinion, this reaction is premature. Eventually, it will lead to a situation that is better for investors, distributors as well as fund companies. Let's see what load is and why this innocuous-sounding reform is so significant.
What is called 'load' in the fund business is the commission that is deducted out of the amount that an investor invests and paid to the distributor who does the selling. Conceptually, it is a fee paid by the investor in exchange of the investment advice and the service (helping fill the form, depositing it etc). The problem with the way load works till now is that it is effectively a single, fixed price for the distributor's services regardless of the actual quality of those services and regardless of whether the investor needs or uses those services. And the price is not exactly low - loads are generally 2.25 per cent for equity funds.
Now, SEBI has said that if an investor goes directly to the fund company without a distributor being in the picture then the fund company should not deduct load. From whatever I've heard so far, fund distributors around the country are in a state of panic. Suddenly they find that they are trying to sell a product that is available cheaper elsewhere and there assumption is that now no one will buy from them. Is this panic justified? I think that given that the load is supposed to be paying for investment advice and service, those distributors who are actually delivering these should see this as an opportunity rather than a threat. But for that to happen, SEBI's proposed reforms will have to be taken a logical step forward.
What is wrong currently (before the reforms now proposed) is that the market for selling investment products has an administered price mechanism. There's only one price and every seller has to charge the same. The new proposal changes this to an administered price mechanism with two prices. The fund companies must charge the lower price and the distributors must (compulsorily) charge the higher price. The law is that it is illegal to give a discount. A distributor can lose his license to practice his business if he gives a discount to a customer. This is an absurdity. I've said this earlier and I'm saying this now that this absurdity is what lies at the root of this whole mess. What the distributor is supposed to bring to the table is advice, consulting and service. Different investors need different levels of these elements and different distributors too have different capabilities of providing these. I think this market can be healthy and open only if the law fixes a maximum load and a distributor is free to charge any level less than that.
If, as an investor, you feel good only when being serviced by a distributor with a global brand, slick TV ads and agents who show up with fancy spreadsheets on sleek laptops then you should pay up the full load. But if you are an investor who doesn't mind learning a bit and doing own brainwork and legwork, then you should be able to save money by going to a discount broker. Isn't that what a market is all about?