SEBI must aim to bring a level playing field between distributors and RIAs

The mutual fund industry has grown 4 times in last 5 years and doubled in last 3 years. In the midst of all this euphoria, comes an awareness campaign by AMFI which says "Mutual Fund Sahi Hai". I doff my hat to AMFI for spreading invetor awareness in such an impactful manner.

The mutual fund industry is at a whopping 20 trillion in value terms currently and this mass media campaign is truly a great endeavour to bring in more retail investors. But, as penetration picks up, it is imperative for each mutual fund investor to know that "Mutual funds sahi toh hai, par free nahi hai".

Price is an important factor in making any purchase decision and hence knowing the price involved while investing in mutual funds is every investors’ right. The fact is that the price involved in mutual funds is quite significant but as this gets adjusted in the NAV, it is largely hidden in nature. One of the main elements of the cost involved is the commission paid to advisors (distributors). Strangely, commissions are deducted till the time you hold the fund.

You probably are aware of the commissions paid to a stock broker or a property dealer, but unlike the nature of these commissions which are one time, mutual fund commissions are on-going expenses. Equity mutual funds are meant to be held for min 5-10 years and debt mutual funds are held for more than 3 years for better post tax returns, so the resultant compounding impact of commissions is huge.

This on-going expense gets deducted from the value of your fund. Imagine, you buy a house to live in and you lose money every month to pay a commission to the broker who enabled the purchase of the house. Moreover, as the value of the house increases, consequently the value of this commission also increases. The worst part would be that if the house owner doesn't get to know that the commission is being paid every month from the value of his house. Quite a scary plight, isn't it?

In most markets, buyers decide the price, but the hidden nature of commissions in case of mutual funds takes away this very important right from investors. As a result, the quality of advice at times suffer as hidden commissions lead to a product level bias and investor doesn’t always get the best and the most suitable option.

Though the mutual fund industry has grown significantly, unfortunately it doesn't yet work on the perfect competition oriented economic system. On one hand the industry is largely controlled by such AMFI registered distributors who charge an on-going hidden commission and on the other there are a handful of SEBI Registered Investment Advisors (RIA), who by fiduciary law don’t charge commissions and consequently work on a more unbiased and investor-centric model.

Investors, who’re largely unaware of the hidden commission cost, presume mutual funds to be free, and this results in RIAs having to consequently struggle to justify the upfront fees they charge. This spoils the competition and hence the industry is primarily controlled by distributors who work on such hidden pricing.

If SEBI really wants investors to get the best, it must aim to bring a level playing field between distributors and RIAs. Why can’t it run an investor awareness campaign that says “Mutual Funds are not free”?

My experience has shown that most investors get a rude shock when they get to know of the long-term compounding impact of commissions. At Bharosa Advisor, we have developed a Free ‘Portfolio Check’ tool which is an online mechanism to know all the good as well as bad facts about the financial health of a portfolio. This covers asset allocation, fund selection, commission expenses.

And once they understand, they never go back to the hidden pricing and opt for an upfront fee based approach. This is where a mass-awareness campaign from the industry and regulatory bodies can help to bring in a healthy competition and can enable investors make an informed purchase decision.