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Commentary

SEBI Notes: MFs, Direct Investing, Brokerage Caps

In the latest SEBI board meeting, a few norms have been discussed that will change the world of mutual funds and personal advise. Note that the actual circulars to implement these changes will follow. (I waited a week, then I decided this post had to be made) A few points that make the grade:

Mutual Funds To Have More Flexible Expense Ratios

Asset Management Companies (AMCs) have complained that they are restricted in how they can use their expense ratios. SEBI has now allowed "total fungibility" in such expenses; only the total number can’t be greater than 2.5%. Earlier they had fees of about 1.25%, other charge

And it *can* be greater than 2.5%. Upto another 0.30% is allowed if funds flow in from beyond the top 15 cities. Note that this doesn’t mean expenses will go to 2.8% – if funds have to remain competitive they must not load the expenses too much; so they will likely still stay around the 2% level which they currently are.

There is a problem – in that the top 15 cities account for over 85% of assets in the MF industry. But it’s further skewed than that. Nearly 45% comes from Mumbai, and more 70% comes from Mumbai and Delhi.

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Further, the top 15 cities keep changing every quarter. Gurgaon was #16 in terms of total AUMs in the Jun 2012 quarter. However, one quarter earlier, it was 14th. I wonder how these things get taken care of. In the 6-monthly disclosures, AMCs need to mention what they are doing to broaden geographical penetration.

Finally, Any service tax charged to the AMC for the scheme was borne by it. Now that can be transferred to the scheme (meaning, investors will pay).

Exit Loads to be Ploughed Back

If you exit a fund early, you may be charged an exit load (usually 1% in equity funds within a year, lesser in debt funds). This money was used by the AMC however they wanted; for paying distributors commissions (an upfront commission could get adjusted this way) or for extra fees.

Now, such loads must be credited back to the scheme. So as an existing investor you will benefit when other people leave early! Bad for the AMC and for agents – they will get compensated lesser.

The Lower Expense Ratio Plan – Direct

All plans of the same scheme (Institutional/Retail etc) will now have the same expense ratios. (So there’s no lower expense ratio for institutional etc.) But there’s one difference: DIRECT plans – where there are no distributors – can be created with lower expense ratios.

This makes sense. Where an investment is directly done by the investor – either by studying the market himself or after following advise or buying online – there is no need to compensate a distributor at all. Agents in equity funds get upto 0.5% per year as "trailing" commissions – if you consider that you make 10% a year, Rs. 500,000 today will grow to Rs. 25.93 lakhs in ten years. At a lower 0.95% per year, you will make 24.78 lakhs – a difference of about 1.15 lakh.

Distributors are crying hoarse that this will hurt their business as investors will choose to go direct. And that this does not benefit the industry. I strongly disagree. Firstly, most distributors – even those I have interacted with – provide very little value addition beyond the initial transaction. They take the cheques, fill the forms and might call you once a year. For that, you don’t pay them 0.5% a year. Some say they provide advice – but they should charge separately for that advice, and this is the concept of why entry loads were removed in the first place. And if they do provide advice that is of at least some value to an investor, the investor should be happy to choose a "non-direct" scheme with slightly higher charges. Come on – if the value you provide gives no perceptible benefit to the investor, then you should not be compensated in an underhand way through higher expense ratios and trailing fees.

Second, there is an obvious benefit to the industry. Most of the corporate money into liquid and debt funds is placed directly with fund houses. Boards will likely dictate that money goes only into direct-only schemes. Of the total 6.89 trillion rupees (689,000 cr.) in mutual funds as of Jun 2012, more than 4.7 trillion (68%) is in income and debt funds; and corporates account for 43% of mutual fund assets. If you consider Rs. 2 trillion on which just 0.1% trail loads are paid which can move into a DIRECT scheme, that’s a saving of Rs. 200 cr. Most of this money, today, goes into the pockets of large banks who are distributors. 

The other benefit is that you have lesser issues with direct schemes – that is, investors can’t complain that distributors misled them or such.

What should happen now is that to make things easier, CAMS and Karvy should come up with a single customer login/password so they can buy any fund directly. That will make things really simple. (And then, most money seems to come from the top few cities, which can easily use the internet and migrate to direct).

Anyhow, this is a sour point for distributors (who will lose the argument since it’s good for investors) and for AMCs who will now have to directly service customers.

Brokerage Capped at 12 bps and 5 bps

Brokers will be unhappy. From earlier charges of 0.20% (20 bps), mutual funds can’t pay more than 12 bps (0.12%) for stock transactions and 5 bps (0.05%) for derivatives.

Regulated Advisors

People who provide financial advise for a fee will have to go through registration and provide information to SEBI. The regulations aren’t yet out (there were drafts earlier) but it seems like people will have to prove they are capable of providing advice, track their customers etc. Such people cannot get paid from Mutual Funds (for trail fees etc.)

There are exemptions – people who give free advice in a broad media (so this blog author will be exempt), stock brokers, AMFI agents (who don’t charge a fee for advice), insurance agents etc.

Other Changes

  • AMFI Fees for distributors will be reduced
  • Upto 20,000 investments in cash will be allowed
  • IPOs can have less than 20% owned by promoters, if the rest is contributed by VCs or PE funds.
  • A new format of disclosure like the 20F form by SEC will be created. This is great – the layer of disclosure in 20Fs is much much more than currently given.
  • Non Retail investors can’t withdraw or change their bids in an IPO. Ooh.
  • ESOPs can’t buy shares in the market. (See My Article)
  • lpm says:

    Deepak,
    Question regarding the ‘Direct’ form of MF investment. I have an ICICI demat account. Now lets say HDFC offered a direct investment MF with low expense ratios. Now if I were to buy this MF through my ICICI online account, would that classify as a direct investment, or do I have to buy through an HDFC website ?

  • shinu says:

    Hi Deepak
    I am from a mutual fund investor from a tier 3-4 city(kottayam). my bank a/c is from a city from withing the 15 i believe [triruvanandapuram]. i am investing through a service provider from chennai… so which catogory i do fall in. any idea?

  • DD says:

    Why are direct plan NAV s more than normal regular plans if cost are less in die=rect plans?? i found it in amfi india website in ELSS SCHEME.
    http://www.amfiindia.com/navreport.aspx#OELSS
    HDFC TaxSaver -Direct Plan – Dividend Option INF179K01YQ8 INF179K01YR6 45.517 45.517 45.517 28-Mar-2013
    HDFC TaxSaver -Direct Plan – Growth Option INF179K01YS4 – 225.695 225.695 225.695 28-Mar-2013
    HDFC TaxSaver-Dividend Plan INF179K01AZ9 INF179K01BA0 45.445 45.445 45.445 28-Mar-2013
    HDFC TaxSaver-Growth Plan INF179K01BB8 – 225.33 225.33 225.33 28-Mar-2013