Podcast |Mutual Funds, Sebi and the regulations

But the market regulator left the door open just a sliver. While it laid down that distributors must not advice, it also said they could explain the features of the products sold. And advisers believe this is as good as any advice. Basically, like the difference between Advise and Advice. See what I mean? You could, if it came down to it, work around it.

These new guidelines are expected to change the business models of many financial institutions, not the least large banks like SBI, HDFC, ICICI, Kotak, which distribute as well as advise on investments. They will have to pick one of the two routes before March of next year. These organizations earn hundreds of crores in commissions so it’s not a particularly difficult guess which route they’ll opt for.

Distributors and advisory lobbies - yes those exist – these lobbies sent suggestions to Sebi, but sources claimed this year’s consultation is the final one in the series of rules regulating how mutual funds are to be sold. ”More or less set in stone,” said the sources.

But the January consultation is not bolt from the blue. Sebi’s push towards the advisory model began almost six years ago. Back in 2012, the agency had said every mutual fund house must ideally have two kinds of plans for every scheme it sold.

A regular plan that an investor could buy from a distributor, and a plan that he or she could buy directly from the Asset Management Company or AMC. There is a prevailing misconception that a mutual fund sold by a distributor is free. Probably because distributors don’t charge their customers.

The earn commissions to the tune of 1.2% from the AMC. Which comes out of the investor’s pocket. SEBI’s concern wad was that distributors were selling products that earned them the highest commissions instead of the right product. Well, where have we heard that before? A salesman selling what’s good for him, not you. After many such stories came to light, Sebi declared mis-selling an offence in 2012.

According to the regulator, if AMCs sold the product directly, investors could save more as the AMCs would be spared the expense of the commission. Direct plans yield as much as 75 basis points to 1% higher saving on equity- based mutual funds.

Usually, only a few investors are equipped with the knowledge to know which direct plan to buy from the massive range of over 2,000 schemes that the market offers. This is where advisers can lend their expertise - on choosing the right product for the customer. And the customer could pay him or her for the professional advice. That is the only way advisers can make money, Sebi declared.

Now, under normal circumstances, you’d expect a change in the functioning of the institutions. Maybe a bunch of new advisers? Considering the monies at play, maybe even a mini industry of advisers who offer investment advice. But, zilch. Nothing happened. Well, did investors move to buying direct plans? Again, no.

By the start of 2018, less than 800 entities were licensed as registered investment advisers or RIAs. Institutions and High Networth Individuals had moved to buying direct plans but less than 10% of the money invested by individual investors in mutual funds comes from direct plans. The smarter investors were buying plans directly from the AMC. Between 60% & 70% of AMC direct plan sales are through their own website, say industry experts.

To make matters worse for advisers, distributors claim their plans are free and go one step further – they share part a of their commissions with investors. As a consequence, investors not only see a mutual fund as free to purchase, they also receive something in return from the distributor as well.
Further, advisers could earn a trail fee from fund houses that paid distributors for the period that investor stays invested; the longer he or she stays invested, the more income by way of commission the distributor stood to earn. The new consultation will dismantle this, well, how shall I put it…quid pro quo?

Expecting such customers to pay for advice is far-fetched, or at the very least, naive.  Also, many advisers had segregated their advisory and distribution activities into separate divisions or companies, as per Sebi Guidelines of 2013, the SIDDS we spoke about earlier. And many such companies or divisions were headed by family members or people close to the advisers. Sebi’s new guidelines stipulate that if a person’s immediate relative – like a spouse, parent, sibling, or child-  runs either of the two businesses, the person cannot serve as the other. If an individual is an distributor, his or her spouse cannot be an adviser, and vice versa.

Advisers say the Indian market is still young, and it is impractical to charge a fee. They claim the larger distributors are audited by SEBI and have to follow the AMFI Code of Ethics. Moreover, they add, there is no way to prove mis-selling, which is highly subjective. For instance, only funds which do well receive inflows. Fund houses that performed badly have lost assets. That’s pretty goof proof, they claim, that distributors mostly act in the client’s interest. They ask that SEBI be more practical and consult experienced advisers and distributors while formulating regulations.

And this regulation could run aground, legally speaking. Rohit Shah, registered adviser and founder & CEO of Getting You Rich, a financial planning firm, lays down a case – “If my brother—who is an independent person—chooses to be a mutual fund distributor, why should that prevent me from being an adviser? Aren’t we living in a democratic country and allowed to follow the professions of our choice?” Hmm, seems a pretty legit grievance.

The January guidelines also mention that banks must choose between the two. For instance, HDFC Bank would have to close down its investment advisory division and continue only the distribution business. Industry experts say off the record that banks will give up their RIA licenses because they have very few clients who are charged only fees. Most banks earn substantial income from commissions from the sale of third-party products. Looking through the data from the mandatory commission disclosures of India’s largest distributors, six of the 10 highest commission-earning distributors are banks. They netted an estimated 1,487 crore in FY17, according to Prime Database’s mutual funds data. With that kind of money on the line, it’s not exactly a mystery that banks would surrender their RIA licences without much regret, should Sebi’s guideline become a law.

Some industry folk do not approve of this move by SEBI. Sadique Neelgund, the founder of Network FP which trains financial planners, said, “For a financial planner to be charging fees from customers and, at the same time, earning commissions from mutual funds is ethically wrong. Ensuring that there are no common customers between advisory and distribution would have sufficed.”

Another outcome of Sebi’s recommendation becoming a proper law would be direct plans getting a push. Advisers could simply switch to offering direct plans. Direct plans are basically meant for investors who invest directly with fund houses, bypassing distributors. Since sellers don’t earn any commission from these, it makes more sense for advisers to offer direct plans to customers and provide both advice and execution services.

Some quarters of the industry say they are now recommending only direct plans to their clients. They have been gradually moving older clients to direct plans and charging them advisory fees. This shift was anyway happening and following Sebi’s latest consultation, the process will only gather pace. According to Prime Database, a large number of debt investments go through the direct channel but less than 10% of the industry’s equity-oriented assets are in the form of direct plans.

And into this mess stepped PayTM. It announced an investment arm, Paytm Money, that wants to be an adviser and sell mutual funds for free. Bear in mind that the mutual funds industry has taken a long time to get to its current 15 million investors. The scale Paytm operates on could have a large impact on the industry. The first product PayTM Money is planning to launch is mutual funds. This came just days after the SEBI recommendation in January.

“Paytm Money…will focus on having all Sebi-regulated products like mutual funds, equities, futures, personal wealth management,” announced Pravin Jadhav, SVP with Paytm Money. He added that the new company had applied for an RIA license and was awaiting approval from Sebi. PayTM Money was expected to launch before March 2018. As of the last week of April, the website home page still says “Coming Soon” and invites pre-registrations.

So what is PayTM up to? Paytm Money claims it will help investors purchase only direct plans and will not charge customers a fee. Initially, at least.
Kunal Bajaj, founder of Clearfunds, a firm that claims 30% of its customers as HNIs, says, “Paytm money will be targeted at the first time, low-ticket investor. Larger investors will continue to need a focused adviser or financial planner to help them through their decisions.”

Paytm’s entry into Mutual Funds could increase awareness around direct plans and disrupt the distributor model, according to industry insiders. They say the industry needs a big hitter to move the needle to direct plans. Following that, the transition could happen faster.

There are more companies like Paytm Money that offer only direct plans—ORO wealth, Clearfunds, Bharosa Advisor. They manage assets under management of between 100 and 400 crores. Their business happens digitally – from acquiring customers to offering advise. Until now though, they had no more than a few thousand investors. While these firms entered this market in the last couple of years, just as mutual funds were on the up, the share of direct funds from retail investors received no traction.

“We took an RIA license at Bharosa Advisor thinking the mass market is moving to direct but…People are unwilling to pay,” laments Kamal Manocha, former CEO of Bharosa Advisor. He subsequently quit Bhaorsa to start an offline advisory aimed at HNIs. He also shares another reason RIAs saw minimal traction. “Distributors sharing their commissions with investors has increased 100 times,” claims Manocha.

For all the splash that PayTM Money is expected to make, mutual funds will not be a money-spinning business for the company. With 200 million customers – these are pre-KYC numbers. The company now claims over 100 million customer have completed their KYC -  Paytm Money is looking to go after existing customers who do not invest in mutual funds. A conversion rate of even 10% of its customer would mean it would have doubled the number of people buying mutual funds.

The average amount people in India put into MFs is between Rs 35,000- 40,000 a year. “We believe while the volume of people buying mutual funds will be higher, the average investment may be smaller to the tune of about Rs 3000,” Jadhav says candidly. He is optimistic that once Paytm can get customers to buy mutual funds, more complex investment products like futures, equities etc, could be introduced, for which PayTM Money could charge fees. It must be noted here that Paytm’s payments bank comes under a different regulator—the RBI.

PayTM Money emphasises that there will be no data shared between the different PayTM entities, but, as business, it only makes sense that the information from that data will help build related businesses.

Experts have noted that there are practical reasons why distributors control a large part of the mutual funds market and why direct plans have not seen traction. The number one reason is the penalty for the investor to move plans from regular to direct. Secondly, no AMC has ever marketed its direct plans to encourage potential customers to purchase directly from itself or an adviser. Why? “No AMC will do that because they don’t want to upset their relationships with distributors,” said a senior executive at an AMC under condition of anonymity.

Large distributors, like NJ India Invest, account for approx. 15% of the 15 million investors in mutual funds in India. Other big distributors are banks. In the last few years, online distributors like FundsIndia, Fisdom and Scripbox have made inroads as well. Most of these firms have an RIA license but very few sell direct plans for a simple reason – they are not economically viable. Plus, customers just aren’t interested. “The cost of delivering advice is much higher because advice needs higher customer engagement,” said another industry expert.

All these factors leave one wondering why Sebi has even allowed distributors more wiggle room. Another expert suggests this is Sebi’s balancing act. To avoid negative impact on the growth of mutual funds, and to also make sure the right product is sold, he says.