Archive for June 29th, 2009

Entry Fee Removal May Slow Indian Mutual Fund Spread

Indian capital market regulators’ move to scrap an entry fee on mutual funds is expected to bring more transparency in the growing industry even though it may temporarily hurt mutual fund penetration as distributors will lose the incentive to sell funds.

In the long run, the move should bring down the cost of investing in mutual funds, attracting more investors and helping the industry grow, experts said.

“The idea behind the SEBI move is to make mutual fund schemes available to the investor at the lowest cost possible,” said Anil Chopra, group chief executive and director, Bajaj Capital Ltd.

The so-called entry load is a fee that asset management companies, or AMCs, deduct from the amount of money an investor puts in a scheme to pay for marketing and distribution expenses, most of which is an upfront payment to distributors as commission.

Last week, C.B. Bhave, chairman of the Securities & Exchange Board of India, said the upfront commission shall now be paid by the investor to the distributor directly, adding that distributors will have to disclose the commission received for their services.

The benefit for investors would be that they now get to negotiate the amount of commission payable.

Also, the removal of the entry load can actually increase the compounded return for investors as the entire amount they wish to put in a fund would get invested.

For example, earlier, if an investor paid 100,000 rupees for a fund investment, he was allotted units only worth 97,750 rupees-97,500 rupees after deducting the entry load.

At present, equity funds typically impose an entry load of 2.25% to 2.50% on their schemes.

Also, distributors will now be more accountable to investors.

Jagannadham Thunuguntla, head of equity at SMC Capitals Ltd.

“This is a path-breaking change, and one which would check mis-selling of mutual fund schemes by distributors,” said Jagannadham Thunuguntla, head of equity at SMC Capitals Ltd.

Mr. Thunuguntla said distributors could now look at turning into advisers who educate investors on the prospects of a fund and its potential performance by demanding an advisory fee in return.

“The taste of easy money (by just selling a scheme) would be gone…the distributors will have to make sure they give the best advice to the investors in order to ensure regular income,” he said.

The SEBI move comes at a time when fund managers are looking to make the most of the revival in Indian markets.

Total assets under management for fund houses in India rose 16% in May to a record 6.39 trillion rupees ($135.90 billion), compared with 5.51 trillion rupees in April, as the benchmark Sensex has soared over 50% since the start of 2009.

Mutual fund penetration in India is still a low 3% of total household savings, and the industry is banking on tapping investors in tier II and tier III cities for growth.

But the SEBI move may limit these efforts in the short-term as the industry may see a fall in the number of distributors, and consequently a fall in business volumes, say analysts.

Experts say distributors might look at other business opportunities as they would now cease to receive the fixed commission from the AMCs for selling mutual funds.

“Selling mutual funds will become much less attractive,” said Dhirendra Kumar, chief executive, Value Research – an independent provider of investment information on mutual funds.

Manish Sonthalia, a fund manager at Motilal Oswal Securities Ltd. said, “(Fund) mobilization would tend to slow down and, even if profitability does not get impacted directly, volumes at AMCs would be hit.”

In the short term, distributors may opt to sell other investment products like unit-linked insurance plans, or ULIPs, pension schemes and post-office savings certificates, which could hurt the asset management industry.

An option out for fund houses is to distribute their products directly, Mr. Kumar of Value Research said.

However, analysts say this is unlikely as setting up distribution centers at several locations across the vast Indian subcontinent would be costly and time-consuming for AMCs.