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Opinion

At Yahoo: Mutual Fund Distribution

I write at Yahoo on Mutual Fund Distribution – The End or an Empty Threat:

Mutual Funds have seen tremendous outflows in the last few months, with another 3,000 cr. leaving equity mutual funds in August. A part of this can be attributed to the lack of distributor interest, after SEBI cut entry loads to zero. The “distributor” (or “advisor”) was supposed to perform the role of both advising you and helping you transact, and made a commission based on your investment amount. The percentage was around 2%, paid out of a 2.25% “entry-load” you paid when you bought the fund. But SEBI scrapped that in 2009 and since then distributors complain that they won’t make enough so they won’t distribute funds.

While I sympathise with their loss of easy income, it’s not like that’s the only reason funds are losing money, and it’s not like the distribution model has no hope.

First, the outflows. Money leaves mutual funds because of multiple reasons – some of which are distributor created. As equity markets scale new highs, the people that were burnt in the great rise of 2007 – when the Sensex scaled from 17,000 to 21,000 in a very short time – are choosing to exit some of their investments made then, having seen the value go so deeply negative in the interim. The “at-least-I-broke-even” trade is just another way our brain functions – it doesn’t want to take a loss. Mutual fund distributors tend to tell their customers to “book profits” as markets go up – partially because it establishes them as having made their clients money, and partially because the money can go into a new fund and thus earn the advisor more commissions on the same amount (“Churn”).

Another reason is the lack of effort at Asset Management Companies (AMCs) in telling people investing is a longer term process. People think of mutual funds as a short term investment primarily because fund houses showcase them that way – 1 year returns, best in the last week, and so on. How can you explain creating a “new” fund that has much in common with an existing, long-running product from the same fund house? How can you have the same fund house investing in large cap equities from four different funds – by just changing names around? Why aren’t the longest running funds highlighted more often? If they keep introducing random products that have nothing new to offer, we’ll all think short term anyhow.

Funds have had problems too – of frauds and excessive fees. From news of dirty third-party cheque fraud, to employees front-running trades and substituting entry loads with arbitrary exit loads. It doesn’t take much for one to get suspicious, and therefore, not to invest – funds need to make efforts to be a lot more transparent.

Lastly, outflows are a worldwide phenomenon right now. Even in the US, money is exiting mutual funds from retail hands. The west has an economic problem, which we seem to not have, but the mentality to hunker down and wait prevails just as much here. There is really no safety net in India, so you can’t blame people for wanting to protect themselves against an imminent global economic downturn.

Mutual funds in India, unlike the west, have outperformed benchmark indices for the most part. Why? Because the Nifty has a highly concentrated set of stocks which have in the last few years done less in terms of growth than the second rung of stocks – the midcaps. A fund that owned a few midcaps and then the large caps would have outperformed, just because midcaps have done way better than the others. Still, let’s call it manager skill – there is no dearth of data that shows how investing in funds would have been better than investing in the index or indeed most other sources. The outflows are not a result of bad performance.

So is the distribution model dead? Can people no longer earn money off selling financial products? Hardly. Most mutual funds still continue to provide commissions, out of their own pockets – between 0.5% to 2% per investment. How can they do this? AMCs are allowed to charge upto 2.5% of the corpus they manage as a fee, and they pass a part of this (and some of the future fees) back to the distributor. You pay, though in an invisible way. Also, all distributors earn “trail” commissions. Stay with the fund for two years, and the distributor would have gotten an “upfront” commission for your investment, and another 0.5% every year for years 1 and 2. As you can see, this is good money.

Also consider the post office. They provide “fixed deposits” for which they pay agents a 0.5% fee. If 0.5% is enough for those agents, 0.5% isn’t too low for the equity fund investment. This is just payment for facilitating a transaction – eventually I could use the internet to get the transaction done for free (many mutual funds allow this now).

Come eventually to the “advice” part. Someone giving you financial advice should be able to charge for that advice – just like you don’t really expect a doctor to treat you for free. But given the massive influx of people who can fill in forms and read web sites who masquerade as advisors, it’s only logical that any request from such people to actually pay for saying “this month, product xyz fund is doing well” will be met with peals of laughter. Some might go a bit further; they give you standard details of asset allocation, or age-based investment, or some such figure they read in an article in some magazine. This is not advice, this is absurd regurgitation. But giving real advice costs money – serious amounts. It usually takes about four hours for someone just to get a person’s data together – and then a couple hours more for working out the advise and so on. This process should cost (in a metro setting) about Rs. 10,000 per person with an experienced financial advisor – not something people are currently easily willing to pay (but I hear there are enough who will pay, btw).

Servicing about 100 customers with Rs. 5,000 a person per year is about the maximum an advisor can do in a first year – that is about 5 lakhs a year in revenue, not accounting for travel and other costs. Scaling further is difficult – if you spend 10 hours per customer per year, and have a 100 customers, you’re spending about 1000 hours on direct customer service; you need the remaining to run around, market yourself and so on. Now 5 lakhs gross in a year isn’t bad at all for a first year, and the running around costs are high today but will come down once distributors are big enough to be able to afford online solutions (which are less than 10,000 rupees a year). Eventually an advisor can service 200-300 customers, using technology and creating templates (for example: saving for retirement has similar concepts that apply to everyone).

Now consider that each customer buys about 300,000 worth of products a year (someone who pays Rs. 5,000 per year will probably do so). That gives an additional 0.5% trailing load, or Rs. 150,000 in revenues in the first year – considering no “upfront” commissions. In four years, just trailing commissions alone will be 6 lakhs per year. This is just mutual funds – imagine more with insurance (even plain term pays 10%), fixed deposits (0.5% to 1%) and subsidiary products like tax filing, health and car insurance etc.

That just means a pure charge-for-advice isn’t currently feasible – but mix advice and much smaller, but trailing commissions and the model is indeed attractive.

There is no reason to think the distribution model is dead – it’s just become a lot more long term. With ver
y little investment and smart execution, just sticking on will make distributors multiples of millions of rupees per year. It’s not going to be easy, but the human touch can’t currently be overridden easily. Let’s now see if these distributors can make the transition to becoming “advisors”.

More Yahoo Columns:

  • Ashwin says:

    >Deepak,

    Looks like your article isn't published entirely at yahoo. I see that your article abruptly ends at this line….

    " Now 5 lakhs gross in a year isn't bad at all for a first year, and the running around costs are high today but will come down once distribut"

  • Anonymous says:

    >A few more words showing up now … 🙂

    "Now 5 lakhs gross in a year isn't bad at all for a first year, and the running around costs are high today but will come down once distributors are big enough to be able to afford online solutions (which are less than 10,000 ru"

  • Anonymous says:

    >Deepak,

    Don't you feel that those Individuals who invest more then 3 lakhs per year should focus on 5-10 stocks and make their own portfolio?
    there are lot of us who hate MFs because of hidden fees and relative under-performance compared to individual portfolios.

  • Anshuk Jain says:

    >same here..

  • Anonymous says:

    >deepak,

    you have mentioned that by raising assets to an extent Rs.3,00,000, an agent can earn an income of 0.5%(trial only and no upfront. This will amount to Rs. 1,500. Why is it that you have quoted Rs.1,50,000 leading to Rs. 6 lacs in 4 years.

    Am I getting this wrong?

  • Deepak Shenoy says:

    >Guys, Yahoo's software had a problem. I see the full content now, is it still chopped off?

    Anon: Yes people can buy their own stocks and I heartily recommend that, because its gives us a lot more flexibility.

  • Deepak Shenoy says:

    >Anon: That's 3 lakhs per customer, 100 customers…

  • Ashwin says:

    >Nopes, the article is still chopped.

  • Shailendra Bisht says:

    >The outflow is getting reflected in the Equity market.NSE is showing 4500 Cr outflow for DII in August.
    Looks like FII who are buying aggressively will not have anyone to sell to if the Outflow from MF's continue.

  • Shankar S says:

    >Deepak, The article is still not appearing in full. While i agree with most of what you say, i believe that the process of removing entry load was haphazard which dealt a blow to the MF business. SEBI should have introduced good gate keeping first, ie ensure that all sales people in financial services have a single certification – today MF Certification is separate, equity sales certification is separate, equity dealer is separate whereas they all deal with the end investor. Along with a good gate keeping regulation, SEBI could have announced variable entry load where the investor signs across what he is willing to pay for the services say subj to a maximum, and announce a time frame for withdrawal of loads. But what they have done is demoralised all including serious distributors and even good advisors. This is if not solely, a serious cause for money going out of MFs, Also even to quote your example a serious advisor with some experience is not going to work for 5 lacs per annum that too before costs, IMHO, s/he would rather work in bank and make more money!, the retail crowd is going to be left out or worse be mis-sold ULIPs!. In its present format this business is dead, while client paying for advise from a state where client used to demand kick back for investing is going to take years. Advisory will become a niche business for the well heeled investors.

  • Anonymous says:

    >still chopped at yahoo -anon

  • Bhupesh says:

    >"This is not advice, this is absurd regurgitation."
    .. but this is what ICICIDirect of any other bank or trading portal (which facilitate MF selling/buying) does in the name of providing planning function.

    In India MF fund need not pay any capital gain tax how much positive return (compared to Index) should be attributed to this? Also how individual portfolio vs MF investing should compare in light of this tax law?