Surviving in the no-load era

In the sweltering heat on an April afternoon, we walked into a narrow and crowded lane in Mumbai's commercial district. When climbing a dingy flight of stairs in a fairly dilapidated building, we bumped into a smartly attired Marketing and Sales head of a large mutual fund. Slightly taken aback to run into us over there, he smiled and made a quit exit. What were we all doing in that building? Visiting the office of a very prominent mutual fund distributor, but for very different reasons. We wanted to know how distributors at the ground level are reacting to the changing industry; he wanted to get them to push up the sales numbers to meet his target.

The heat is on
Mutual fund heads are sweating it out. And it's not just the heat, though that too. Their woes began in 2008.

Early that year, the market regulator, the Securities and Exchange Board of India (SEBI) mandated that no mutual fund, whether open ended or closed end, could charge initial issue expenses from the schemes' net asset value (NAV). All funds would now have to dig into their entry loads only. Prior to the ruling, this regulation was applicable only to open-ended funds. Now, Asset Management Companies (AMCs) could not use the launch of closed-end schemes as an excuse to enable them to pass on some amount of the initial issue expenses to investors. Soon after, the global equity market went into a tailspin and India was not excluded. In the last quarter of the year, the liquidity crisis hit the mutual fund industry hard. All were happy when 2008 was finally history.

Unfortunately, the regulator was not done with them. After a very tumultuous 2008, the fund houses had barely got back on their feet when SEBI decided that mutual fund distributors needed to be put in place. So in the second half of 2009, entry loads were completely banned.

Distributors threw a fit. With entry loads no longer available, a lucrative source of income was snatched away from their hands. “I used to make Rs 22,500 if I got business of Rs 10 lakh,” moaned one distributor. And this was not taking into account trailing or upfront commissions, the latter being much higher in the case of new fund offerings (NFOs). With such revenues, distributors could not imagine a life without entry loads and because mutual funds could not imagine one without distributors, they moved fast to pacify them. Some promised to hike the trail commission and even pay a part of it upfront. Others promised high upfront commissions. One of the larger AMCs actually sat down with their key distributors to discuss targets and promised a 'monthly income' based on those figures.

Logically, fund houses should be happy with the SEBI regulation. After all, they have their frustrating moments placating distributors. The head of a mutual fund once told us how a distributor blatantly informed him that he was tired of being taken to Singapore or Hong Kong as part of a 'rewards programme'. He wanted to know if trips to more “exotic locations” like Turkey could be organised instead. But regrettably for mutual funds, the ban on entry load was not great news because the fact of the matter is that distributors play a key role in the mutual fund industry, a reality that industry players believe SEBI has ignored. In fact, the prime driver of growth in the mutual fund industry in India has been distribution, followed by branding and fund performance. “In this industry, we do not interact directly with the client but through an intermediary. So, hypothetically speaking, if all distributors wake up tomorrow morning and decide to stop selling mutual funds, I don't think the AMCs will have a clue on how to proceed,” said a CEO. In a nutshell, mutual funds are in no position to anger their distributors.

And angry they are. Here's what a prominent distributor had to say: “The 80:20 rule applies to my business; 20 per cent of my clientele gives me 80 per cent of the business. Why should I waste money servicing the balance 80 per cent? At one time I could but today a lot of expense is going out of my pocket. And they don't want to pay. I have no time to haggle with anyone, so I am just going to tell them that I am not interested anymore.” When reminded that it would be the retail customer that would suffer from his attitude, his answer: “I am not here to do charity, I am here to run a profitable business.” Now with distributors miffed at the way SEBI is targeting them, sales heads are scratching their heads wondering how to deal with this problem. And one of the ways is by offering huge upfront commissions. A short while back, a distributor told us he was earning a fair bit by selling equity linked savings schemes (ELSS). In 2009, a high upfront commission would be around 1.50-1.75 per cent. But in the run up to the end of the financial year (March 31, 2010), fund houses went all out to bring in the money by offering huge upfront commissions on the tax saving schemes. The upfront commission varied from 2.25 per cent to a very lucrative 5 per cent. This upfront commission was paid on the premise that the distributor would not earn a trail commission for the next three years. The logic being that an investor would have to stay invested in an ELSS which has a lock-in period of three years.

Then SEBI intervened once again. Starting this financial year (April 1, 2010), all AMCs were told not to pay upfront commissions to distributors from the load account. They can do so only from the recurring expenses account or from their own pockets.

The exodus
Numerous distributors, unhappy with the way SEBI is targeting them, have decided to walk out altogether. Unofficial figures state that 15,000 IFAs, whose ARNs were up for renewal over the past six months, are not renewing. A big distributor told us that he would send someone to the investor's home to drop a form, get it filled and then return with the transaction slip. Now he tells investors to make the trip to his office and come by a few days later to pick up the slip.

A bank distributor echoed a similar sentiment. He would sell mutual funds but no longer aggressively push it. “Just 10 per cent of my revenue comes from funds. This was 25 per cent a couple of years back. Why should I waste time, energy and resources on it?” he questions. A sales head of a mutual fund was narrating to us his experience of travelling to Tier II towns to talk to distributors. All their woes were summed up in a sentence and a question. Rentals are increasing, salaries are increasing, inflation is rising and cost of petrol has risen. So why stay on in a business where revenues are falling? Mind you, we are not citing remote instances. This is more or less the overall mood of the distribution community, be it National Distributors (NDs), Independent Financial Advisors (IFAs) or bank distributors. An IFA told us that to service half of his clients, he would have to bike it down to their places to give them the form and fill it up and then make another trip to hand over the transaction slip. If his clients do not pay him enough to cover his petrol costs and make a profit, he sees no point in servicing them anymore. “Clients are just not ready to pay,” he says. His plan of action: sell other products, put mutual funds on the backburner.

When we spoke to individuals in the industry (CEOs, heads of marketing and sales, country heads), the views we got were very conflicting. But there was unanimity on one front - none of them wanted to be quoted or even vaguely referred to. The second point which they were willing to concede to was that it was inevitable SEBI would take this path to curb the excesses in the industry. What got to them was the timing. Reeling under the shock of 2008, the worst year in the history of mutual funds, they felt SEBI should have waited for the industry to pick up before slamming them again. Distributors echo a similar view. While they agree that this is the path a mature industry would drift towards, they are also of the opinion that SEBI never gave the industry time to adjust to such a fundamental change in the distribution process (please read the interview on page 34 to see SEBI's articulated view on this point). The regulator in the U.K. too plans to implement a ban on entry loads but has actually given the industry a few years to prepare for it. “The Indian retail investor is just not prepared to pay for this service. Which is fine. But then don't expect me to service him,” said a smaller distributor. “SEBI is moving towards a more mature environment but I don't see the investor as being mature enough by doing his part and offering to pay.”

Lack of awareness
The general sentiment is that SEBI is so busy focussing on the few issues that it has missed the big picture at hand. And that is: other than via mutual funds the retail investor has no way of being part of the Indian growth story. “What SEBI must realise is that the insurance industry grew simply because of its distributors. If distributors walk away from funds, they will tout other products. The only vehicle which a retail investor can ride to participate in India's growth story is a mutual fund. But no one will sell him that,” says a CIO. He has a point. Distributors are selling unit linked insurance plans (ULIPs), corporate fixed deposits, post office schemes, bonds and the bigger ones are offering direct equity. From September 2009 till March 2010, the net inflows into equity schemes have been negative, barring January and February.

Little wonder that the top brass at AMCs are wringing their hands wondering how to keep their distributors happy and in the bargain make money for themselves too. According to a survey by KPMG and the Confederation of Indian Industry (CII), titled Indian Mutual Fund Industry - The Future in a Dynamic Environment, data in FY08 showed that Indians still favour bank fixed deposits (55%) and insurance (18%) to mutual funds (7.7%). According to the Invest India Incomes and Savings Survey of 2007 conducted by IIMS Dataworks, only 1.6 per cent of the respondents, who were individual wage earners in the 18-59 year age group, invested in mutual funds. Despite the low penetration, what has been ironical is that over the past years, the number of AMCs has risen and so has the number of distributors. But when one looks at the number of investors, there has not been any growth to speak of. The CEO of a fund house elucidates this point well with the following figures. “In 2000-01, the Sensex was at 4,500 and industry equity assets under management (AUM) was Rs 60,000 crore. The market is up 4x at 18,000. So by that calculation, equity AUM should be at least Rs 2,40,000 crore. But it is not. So in the past 10 years where has the growth been? The industry has actually de-grown. All the AUM growth is in debt, where just 20 per cent is of retail money.” Now with distributors throwing their hands up, mutual funds are pretty clueless (at least right now) on how to tap smaller investors and make massive inroads into smaller cities.

The road ahead
It's tough. For everyone concerned. The bulk of distributors have reacted negatively to SEBI's regulations. And it is the small investor who is facing the brunt. They are finding it difficult to easily access distributors willing to help them out with transactions. Now they will have to ensure that they do the running around themselves or get acquainted with the idea of paying for services provided.

But is SEBI really killing the industry? No, we do not believe that. Distributors were taking investors for a ride and the regulator had no option but to step in. However, transition periods are rarely comfortable. So though the mutual fund industry is going through a rough patch, it will emerge out of this slump. A look at the how the more developed markets reacted to such regulations would give us a better perspective on where SEBI is attempting to take the industry. After Australia abolished the entry load, the number of distributors in the market dropped drastically (estimates put it at 90%) while online platforms made an emergence.

Those distributors that stay on will rework their business models. The market will evolve into one where value addition is a key factor and the distributing community gravitates towards being more investor centric. Last year, PricewaterhouseCoopers conducted a mutual fund survey in Canada titled Restoring Lost Confidence - Insights From The Industry. PwC commissioned Leger Marketing to conduct an online survey between March 25 and 30, 2009, where 1,680 adults were interviewed. Despite the poor investment results led by weak markets, 75 per cent stated that they continued to trust their financial advisor. Interestingly, when asked if investors would be better served by directly investing in mutual funds without the advice of a financial advisor, only 23 per cent agreed. The CEOs surveyed separately were of the view that the full advice channel would continue to be a significant form of mutual fund distribution moving forward.

Several mutual funds have already begun to think of more innovative measures for enhancing fund penetration and awareness. They are hoping that they will get tax breaks on expenses related to investor education and awareness programmes. While the universal opinion is that technology is the way forward.

Distributors feel cheated. However, with the amount of mis-selling that took place, it is only right that SEBI bats for the investor. Eventually, the investor is the one who will benefit from all these changing industry dynamics. And those distributors who change tack to offer unbiased quality advice to investors will be the ones to survive and even flourish.