This morning, I wrote a column commenting on SEBI's new move to add distributor commissions as well as a comparison of direct plan and regular plan expenses in the Economic Times. This column was also published on Value Research Online (<https://goo.gl/GSj8qY>).
A number of readers have responded by saying that I'm arguing against transparency and and against direct funds. This is not correct. Higher transparency is a good idea, direct funds are a good idea and certainly, mutual fund costs should be lower. There can be no two ways about it.
However, the kind of fund investor represented by Value Research's or Economic Times' readership is not typical. These are knowledgable and aware people who can very well invest in direct funds themselves. All they need are the inputs provided at Value Research. However, the entire universe of Indian fund investors (and more importantly, potential new fund investors) are a different matter. They are not going to magically dream up the knowhow required to become direct fund investors. There's a huge (and crying need) for expanding fund investments in India, and the independent fund distributor is a crucial part of realising this potential. And surely, I don't need to point out that the distributor is not going to survive on love, encouragement and fresh air.
So, I'm certainly not opposed to low cost, or to direct plans. However, I'm opposed to this method being followed by SEBI in lowering costs. There's a certain maximum cost that SEBI allows funds to charge. Obviously, no one charges more than that. If SEBI wants lower costs, then it should lower the cost limit and expenses will instantly be lower. It's as simple as that.
Instead, it has decided to go about things in a convoluted manner and structure the account statement in such a way that it is thinly disguised invitation for investors to abandon fund distributors and switch to direct funds. The strange thing is that there are no rules (not even guidelines) for expenses charged under direct plans. In fact, most funds appear to be charging more for direct plans than they should.
The differential between direct plans and regular plans is much less than it should be. In fact, if one examines the average direct plan expenses between different AMCs' equity funds, it's pretty clear that there is something strange going on. Consider this: some fund companies' average direct plans cost is as low as 0.8-0.9 per cent, and are cheaper than regular plans by 1.2-1.4 per cent. At the other end of the scale, others' direct plans cost a whopping 2+ per cent and are just 0.2 - 0.3 per cent cheaper than regular plans. What's going on here? Is SEBI asking any questions?
For everyone who is bothered by higher cost, here's a set of self-evident questions, and what I think are the correct answers.
Q. Why are costs high? Specifically, why are Indian mutual funds more expensive than US or European ones?
A. The immediate answer is because that's the limit that SEBI has imposed (see above).
However, the limit is not without logic. In India, the average investment size, specially of the starter investor, is quite low. ₹5,000 to 10,000 means that a newly acquired customer is worth about ₹100 to ₹200 to the distributor. Maybe a little more, but not much. Not just that, a distributor may have to pitch to many customers to convert one. Mind you, SEBI itself has affirmed the principle of high cost being an acceptable trade-off for expansion of the market for funds when it allowed funds to charge extra from all customers if they expanded in the smaller cities.
Q. What is the best way to pay for expansion of mutual funds?
A. If a new customer has a ticket size of ₹5,000 to 10,000, then there is no way that his first few transactions can pay for expansion. Customer acquisition cost will have to be paid for either (1) Over a long lifetime of that customer, and/or (2) by high-value customer pushing up the average take per customer. However, (and this is the most important thing) SEBI's current move tries to eliminate both these, because as customers get experienced and knowledgeable, they will move to direct.
Q. What can be done?
A. As I said above, if SEBI wants lower expenses, then it should just lower the expense ceiling. It shouldn't try these roundabout ways of squeezing people.
Furthermore, it should: (1) Allow, legal, upfront passbacks. This will let low-cost distributors compete on price, as happens in every industry. The idea that every supplier of a goods or service must charge the same price is market interference of a most counterproductive kind. (3) If SEBI doesn't want distributors, it should say so. It should give a transition period, and force the entire industry to move to an advisor model. If people have to be put out of business, then they should know what is happening. (4) SEBI has talked about online and ecommerce models. How will these model operate if everyone is forced to charge the same as high-cost non-online that banks have? Online fund advise/distribution in India may be a non-starter as long as the regulator says there are only two models possible: either full cost, or zero cost.
Bottomline: Small distributors are not the enemy. They play a crucial role in expanding the industry. Only they can afford to operate within the tiny commissions that small investors generate. If you want to kill them, go ahead, but it's a blunder.
Let them capture small customers, and offer discounts to customers as the latter grows big.
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