Today, markets and investments regulator SEBI has unleashed a set of fundamental, ground-breaking changes to the regulations governing mutual funds in India.
I had a strong sense of deja vu as I wrote that sentence. I've said the exact same thing perhaps twice earlier in about a decade. Each time, it was true but this time, it looks to be the a bigger deal than the first two times. The business model of all fund companies, as well as all fund distributors stands transformed.
While SEBI has also reduced the expenses that funds companies can charge from investors, the big change is that it has outlawed the upfront commissions that fund distributors get for getting investors to put money into a fund. Instead, they will only get what is called 'trail' commission. 'Trail' means a steady, small percentage that the distributor gets as long as the money stays invested.
This is actually a very big deal. The reason is that while it appears to be superficially about commissions, it's actually an attempt at triggering a deep change in distributors and fund companies' business model so that their economic interest aligns with that of the investors. An upfront commission means that whenever an investor makes an investment, the distributor who facilitated it gets perhaps one to two per cent of that amount. This means that the distributor's interest lies in getting a transaction done. To make more commission out of a given customer, the best strategy is to keep moving the money and creating more transactions.
Now, SEBI has outlawed upfront commissions. Distributors can only be paid trail commissions. There will not be any incentive for switching money around for the heck of it. As long as the investor is invested, the distributor gets a steady stream of revenue. That's it. It sounds simple, and in terms of the benefit that brings to the investors, it is. However, over the years, I have observed that in many fund companies and in distributors, there is a deep culture of hard-driving sales teams out to get as many transactions done as possible. That should change now, even if gradually.
Earlier, the name of the game was to move the money by whatever means possible. Now, it will be to get the money into a set of good funds where the investor will be happy to stay for a long time to come. Not only will sales need a different approach, it will need a different approach to business, even a different kind of person.
In SEBI's decisions today, there are other far reaching changes as well. Not only have expenses charged by funds been slashed, their structure has been changed in an important way. There is now a serious sliding scale whereby larger funds get a much less percentage of assets as revenue. This works to the advantage of smaller fund companies which are having a much harder time than the giants.
In fact, SEBI's entire set of changes are essentially a strong rebuke to fund companies. The official statement said that, "The Board took note of the benefits of the proposal with respect to sharing of economies of scale, lowering the cost for mutual fund investors, bringing in transparency in appropriation of expenses, and reducing mis-selling and churning"
Whether it's practices surrounding commissions, or the high expenses, the changes are intended as a fix for malpractices. For example, it is customary for fund companies to pay commissions to distributors through a variety of accounting routes. Now, SEBI has said that "All commission and expenses, etc. shall necessarily be paid from the scheme only and not from the AMC/Associate/Sponsor/Trustee, or any other route." This is a specific reference to the kind of malpractices that have developed.
If the past is any guide, there will be attempts to find loopholes in these new rules. However, I get the feeling that the regulator is now in a mode to not tolerate anything like that. In the weeks and months to come, I'll track and discuss these changes and their real world impact closely. However, as of now, it does appear that fundamental, pro-investor changes are imminent.