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Commission Oriented Advise

A Jagoinvestor Forum user asked this question:

One agent suggested to invest lumpsum into Reliance MIP (say abour 3 lacs) and choose the growth option.  After one year, go for a SWP from the scheme ( of about 3000 rs) investing the same as SIP in an equity fund to get a balanced mix of debt/equity.  Your comments on this is most welcome

I answered, but I think the answer needs elaboration:

(SWP=Systematic Withdrawal Plan, SIP: Systematic Investment Plan. You either put in or take out the same amount of money every month, automatically)

If you do this, you will pay commissions twice – once while getting into the MIP (REL MIP btw, currently is giving 1-1.5% upfront commissions) and then again when getting into the equity fund (again, 0.5% to 1%). You don’t see these commissions in your fund NAV but it is something that is being paid through the management charges, so you pay them indirectly.

The agent wants you to do this so it gives him:

  • Upfront commissions on the 3 lakhs (of say 1%, Rs. 3,000)
  • Trailing commissions of about 0.5% on the MIP for a year (0.5% or Rs. 1,500)
  • After a year, say you withdraw and invest Rs. 25,000 per month. He makes 1% on each equity entry as commissions (Total in 2nd Year: Rs. 3,000) and an additional Rs. 1,500 as trailing commissions (same for equity or MIP).

Effectively you pay 1.5% as commissions in both years. Had you SIPed only into the equity fund, you would pay 1.5% in year one, and 0.5% from year 2 onwards.

Awesome Commission Deal

Never transfer (STP) from MIP plans to Equity plans. Why? The MIP already has about 20% equity exposure! Why would you transfer from a part-equity plan to a full-equity plan? It is much better to STP from a Liquid fund or a floater fund into an equity plan.

Also note – why is he asking you to do this after 1 year? Reliance MIP has an exit load of 1% if you leave earlier. If you want to do something like this consider buying a Reliance Short Term plan (no exit load) and transferring slowly into an equity fund starting now (why wait a year). This is something your distributor will not like, since commissions are lower, but it’s far better for you. 

I wouldn’t advice throwing in a lumpsum into the equity markets – if you have a ton of cash you need to invest, just buy a short term fund and let the money flow into equity regularly.

(Note: This is still lesser than what you would pay for an insurance plan.)

  • vivek says:

    >It looks like its the same as if there were entry loads? Just not explicit as was before. The ban didn't really have any effect?

    I didn't understand how the upfront is deducted though. If the upfront is part of the management fees. it must be deducted from the NAV no? What other mechanism is used to charge the investor?

  • Deepak Shenoy says:

    >The management fees are charged on a daily basis for the rest of the year, the AMC pays the upfront out of it's own pocket but recovers it from the fund. Should you exit early, you get hit with the 1% exit load which will cover the commission.

  • vivek says:

    >The accounting is unclear. Seems like some portion is covered by exit load (applied during exit but how is aggregate exit load collection reported by the fund?) and some is accounted in the expense ratio and gets subtracted from the NAV on an amortized basis? So, if all investors of a fund hold on for longer than a year, expense ratio will be high since it has to cover for all the upfront paid. On the other hand, if most investors are paying exit by holding for less than a year then expense ratio would be lower.
    Trail is also a part of the expense ratio? At the end of the day, the total fees from one investor's standpoint is just the expense ratio and exit load, isn't it? There are no other fee events?

    It seems like there was a SEBI order applicable from April 1 that they can't pay from their pocket. And, also upfronts may be going down with trail going up instead: http://economictimes.indiatimes.com/personal-finance/mutual-funds/mf-news/MFs-slash-upfront-agents-fee/articleshow/6060777.cms

  • The Financial Literates says:

    >Why Agents are Mis-selling MIPs now a days

    After the ban of entry load since August 2009, Suddenly MIPs have become one of the most recommended product by Mutual Fund Distributors. Is MIP one of the best product for investor? Frankly speaking, the intention of distributors is not to offer the best product to investors but the intentions is to make the most from the clients. MIPs now offer more commission to mutual fund distributor than Equity Funds STP (Systematic Transfer Plan) to Equity through MIP is again a very expensive thing for investor but very lucrative for Agent.

    From the last 1 Year, the corpus of MIP schemes have seen a huge inflow all over India. Last year, the total industry AUM was close to Rs. 3700 crore and today it is well over 24500 crore. In this entire period, equity funds AUM have gone down. Now when the intentions itself are not good, needless to say that the outcome will be right. Many investors are not aware that there is an EXIT Load of 1% in almost all MIPs if you were to withdraw before one year & in some cases even 1.5 years.

    Make no mistake in choosing MIPs. It is better to invest only if you need it. Don’t use it as parking investment as it could be costly mistake.

  • Anonymous says:

    >Fianacial Literate:
    You should see the broader picture. MIPs are being sold to retail by Agents as a way to beat fixed deposits since it has a equity component which they say will perform well if the equity markets perform well. If some retails feel that equity markets are overvalued and want to get out of Equity Funds where will they park their redeemed funds? Either go to Debt Funds, Short term Funds or MIPs. All the Debt funds also have similar exit loads like MIPs. Short term funds returns are poor. Other alternative is Gilt Funds. Even here reputed funds charge 1% exit load except for few funds. Today DSP-BR has come out with bullish call on gilt funds. But for retail to switch to gilt funds is risky. So they feel safe with MIPs. Other way is to short Nifty thro F and O but retail will not go there. So there seems to be no near term solution for retail.

    MK

  • Anonymous says:

    >MK,

    The MIP will also not do well if you expect markets to not do well. A MIP can also be replicated by allocation between funds in a short term fund and the rest in equity. So, your points don't make any sense.

  • Vinaya H S says:

    >In my opinion, MIPs (growth option) are a good option to automatically meet your debt:equity target especially when they're on the conservative side.

    Example: If your debt:equity target is 70:30, find a good MIP that by and large sticks to this ratio (example: HDFC MIP Long-term Plan Growth).

  • Anonymous says:

    >Some very informative posts here. Thx to all.

    But my qn is, if the person has a lump sum of Rs. 3L to invest, why not just opt for the easy solution of: a) Put this into a linked-FD (no lock-in period) of his savings account (many banks offer this), which would offer ~6-7% risk-free / load-free and then b) start channelling funds from this into an SIP (say Rs. 25K / month)

    Any flaws in the above option? Thx.

  • Deepak Shenoy says:

    >Anon: That's a good option. Only thing I can think of is taxes – You get tax deducted at source on interest redeemed on the linked FD, I think, versus no such issue with a short term mutual fund. But at 3L it may not be a big deal.

  • Anonymous says:

    >Fibally it all depends on individual situation. If you are uncomfortable with present Equity Valuations then you can choose many variants of funds available. But one should be fully informed about plus and minuses of these funds. No doubt MIPs Nav will also fall with market. But a good MIP fund manager can take calls both on Debt as well as on Equity. Most MIPs have mandate to vary Equities from 0 to 30%. Similarly in Debt category he can opt for various papers. So overall MIPs may not be that bad. I also feel growth option of MIPs are good way to play. More important than Agents Commission is Tax outgo. One has to plan this carefully.

    MK

  • Anonymous says:

    >Thx for your reply Deepak. I guess I did overlook the tax aspect, although as you pointed out it won't be too large for interest on Rs. 3L.

    And thx for your efforts in creating this terrific blog!

    MB.

  • Anonymous says:

    >dear all !
    Any AMC can charge upto 6 % as charges but from august 1 st 2009 the entry load is abolished ( 2.25 % ) the remaining 3.75 % towards fmc and others.
    thanks for this service.

  • Veng says:

    >Can we discuss like, is it a good option to go for MIP and do STP from there, based on the returns and not guided by how much the distributors eat in between.
    Frankly speaking, is there a better result (in terms of gains) in any other option similar to MIP+STP+SIP? I am interested in having that.
    Don't think I am a agent or a distributor, I am an investor who has 3L for deployment, I want to have the best option from you.
    Deepak ji, thanks for raising this topic.

  • bugzwurld says:

    >Given the Current market levels, I think MIP is fine. I see no problem, with the STP from MIP (though I agree the IFA's motive may be monetary).

    With both Short Term Plans and Income funds having MTM components, I see no reason why an STP from MIP should not be done. Though SIP is the better route.

  • Anonymous says:

    >I dunno but at this market my recommendation would be to go for any good AMC liquid plus fund to park your money and than do STP from Liquid to Equity. And I would say if you are really interested park your money in IDFC Money Manager Fund- Treasury Plan and od your STP to IDFC Premier Equity, I am sure you can get really very nice returns.