Fix local distribution before wooing foreign money in MFs

What the government and regulator needs to figure out urgently is ways to increase domestic retail inflows into mutual funds, writes Rajeev Thakkar, CEO, Parag Parikh Financial Services.

Recently there has been an announcement that foreign individuals will be permitted to invest in Indian mutual funds. Most investors who are keen on emerging markets like India would already have invested in their local mutual funds with exposure to Indian investments. In the absence of marketing network and / or tie ups with local players, it is difficult to imagine that Indian funds will see a lot of inflows from foreigners. We need to get the local distribution model right for the sector to really grow.
A lot has been written about getting the distribution system in place for mutual funds. There are sometimes diametrically opposite views expressed on this subject. At one end of the spectrum there is a view that whatever is the least cost method for the investor namely a direct investment option for the investor without entry loads and with minimal trail commission (if any) to distributors. At the other end there is a clamour for a return to the high entry load regime as prevailed in the past.
The correct path as in most cases lies somewhere in between. It is obvious that some remuneration for the distributor is required for the investor to have appropriate access and to get good service. Just as Hindustan Unilever does not sell soap directly to all the consumers, it is unrealistic to expect investors to access mutual funds without distributors. A direct channel can exist as an alternative to distributors but the number of investors availing of the same will remain small till the time technology, internet penetration and awareness improves.
At the same time it cannot be denied that there were widespread abuses in the entry load regime that existed earlier. An upfront commission for mutual funds cannot be compared to the upfront incentives for instruments like national savings certificates or in the case of life insurance policies. In case of national savings certificates, the investments are locked in for a long period of time while in the case of life insurance policies, not only in the investor locked in, he also commits to pay a certain amount regularly for an extended period of time.
An upfront entry load is surely feasible for close ended mutual funds. However where a large upfront commission is paid in case of open ended mutual funds, there is a lot of temptation to the distributor to churn the portfolio frequently in order to get the upfront load on a periodic basis. It is the investor who ends up losing here without there being significant increase in the total funds under management for the mutual fund sector. If an investor stays invested in an equity mutual fund for say a period of six years and the fund pays a trail commission of 0.5% per annum, it would add up to a 3% commission over the period of investment. This level of commission would be comparable to that received by distributors of small savings instruments.
Of course there are administrative costs associated with client acquisition and in completing the KYC requirements and operational aspects of a new application for mutual funds. The right level of administrative charge to be paid by the client and correct level of trail commissions can be debated. A very large upfront commission however where there is not restriction on redemption of the fund is prone to misuse.