Is Fund Distribution a Dying Business?

The availability of direct, non-intermediary fund investment options may have sounded the death knell of the fund distribution business

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The mutual fund distribution business is headed for extinction. As a cumulative result of regulatory changes that SEBI has made over the last five years, the distribution business is in severe decline and no one should be surprised if within a year or two, there is only negligible fund distribution activity remaining in India.

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This is the inevitable conclusion from a study that has just been conducted by Value Research. The study was conducted at the end of the first year during which the availability of direct (non-distributor) mutual funds have been made mandatory by SEBI. It's the first study that compares the assets under management of each direct fund scheme with those in the matching non-direct scheme. This is the best way in which investors' relative preference for the direct vs non-direct route can be understood.

For those not familiar with the terminology, here's a recap of what a direct fund is. From January 2013 onwards, SEBI has made it compulsory for all fund houses to offer a Direct plan of each fund. These direct plans have the same investment management of the original funds but are sold directly by the fund house to the investor without going through any intermediary. The distributors' commission and other intermediation expenses are not charged to direct funds and therefore, direct plans have somewhat higher returns than the equivalent non-direct funds. Over the last year, the differential in returns has averaged 0.21 per cent for fixed income funds and 0.58 per cent for equity funds.

So why am I saying that the fund distribution business is heading for extinction? The data show that during this year, as much as 30 per cent of the total assets under management by funds are now in direct plans. This is a very high number and could well account for almost all the fresh inflows into many funds. If we look at different types of funds, the story becomes even clearer. For this purpose, let us divide the entire universe of funds by what is the general timeframe of the investments made. We should do this to better see direct plans in the context of fresh inflows. In liquid funds, where investments are generally in the order of a few days or weeks, direct plans are now 50 per cent of the total assets. In non-liquid fixed income funds, where investments are of the order of a few months to years, they are 26 per cent. In equity funds, where investments are for a longer term, and are often in the form of long-running systematic investment plans (SIPs), direct plans account for about 3 per cent of assets. Broadly, the proportion of direct investments are in the same ballpark as fresh inflows into that category in a years time.

Let's overlay this data-driven picture with some qualitative impressions gathered by talking to investors, distributors and fund houses. Privately or publicly, everyone admits that almost the entire professionally-driven investor category--meaning corporates who park money in liquid and other debt funds--have moved en masse to direct plans. No matter how small the advantage, corporates have dedicated in-house finance people to manage money so they are just not interesting in paying extra for any intermediation. As far as individuals (typically equity) investors go, the level of interest in direct is proportional to the investor's knowledge and experience level. Small, new and occasional investors are going through distributors, larger and more knowledgeable investors are rapidly switching to direct.

I'm not quite sure whether to call this decimation of the distribution business an unintended consequence of the new regulations--after all, direct plans are specifically intended to eliminate intermediaries. However, the fact remains an entire business has been eliminated. What's more, the only likely-looking survivors are the distribution businesses of banks, which happen to be the ones most prone to abusive practices. The individual distributor--who in many ways was uniquely suitable to bringing in small retail investors--will soon be a thing of the past.

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