It is now close to three years since the market regulator SEBI abolished entry loads on mutual fund investments. In these three years, the business model of mutual fund companies as well as distributors has changed considerably. Large parts of the industry are in financial distress, or, at the very least, not enthusiastic about the future. The number of active distributors is also going down. All this is affecting the growth of the investor base with the number of active folios actually going down.
In recent weeks, the entry load abolition has suddenly started being discussed again. Now, three years later, the mutual fund industry has started speaking out clearly about the business impact of the change. A few days ago, in an interview to a newspaper, the head of AMFI (the fund industry’s association) said that the negative impact of the decision should be debated.
I do think the abolition of entry load has played a role in the distressed state of the mutual fund business, but it’s probably not a central role. SEBI’s crackdown on frivolous NFOs and the long stagnation in the equity markets have also played their parts.
However, that does not mean that there’s a case for simply restoring entry load in the same shape as it existed till July 2009. It must be remembered that at that time there was a valid context for SEBI’s action. Churning of investors’ fund holdings in order to earn commissions out of the entry load was a widespread abusive practice among some distributors, as was the NFO-and-dump cycle of investments. The heady days of 2004-2007 were basically one long party of endless NFOs and repeated churning of investments.
In any case, an important component of those prosperous days was the continuous rise of equity markets. I think if all the other components had been present but the stock markets were as moribund as they have been since 2009, then the NFOs would be of no use.
It’s logical that the solution must come from the creation of a business model that explicitly links the economic interests of the distributor with the interest of the investors. Think of it in a simple manner. For example, the interest of the investor lies in being recommended a good fund, starting an SIP in it and then sticking to it. How we can align the distributor’s interest with this? Perhaps by giving him a more substantial (and possibly escalating) trail commission if this outcome is achieved.
This is just an example of how distributor business model and remuneration should be directly linked to the actual desired outcome. In this regard, SEBI’s abolition of entry load missed a trick. The goal should have been the abolition of upfront commissions because of the churning-type abuses. What it did instead was to ban entry loads since commissions were paid out of the entry loads. However, the commissions are still paid but out of the AMC’s pocket.
From here on, the way forward would probably be for all changes to be directly linked to the desired outcomes instead of hoping for the outcomes to be a side-effect. For example, if expansion to smaller cities and first-time investors is a goal, then the AMC and the distributors must be able to derive a meaningful economic payback for delivering these outcomes. Exit loads could play a role here.
The fund industry’s starting viewpoint – that the entry load ban may have been counter – productive-is correct. But the solution doesn’t lie in turning the clock back.