Equilibrium in MFs is in investor interest

As a kid, I had this toy that worked on the principle of balancing. It had two arms and no matter what contortions one subjected it to, it would sway, swing, wobble and come to a stop in the upright position.
It’s the same with the market — equilibrium would be reached as the various constituents act out their parts sensibly and the valuations are discovered, after factoring in all that is known - I have since realised.

Mutual funds are a very important component of the investment landscape. They act as a buffer between the investors and the stock market and reduce the risk by diversifying the investment, offering the services of a professional fund manager, ensuring liquidity at all times, etc.
But somehow, mutual funds have been portrayed as villains by the media and Sebi also seems to see the industry as fleecing the investors, which is unfortunate. The no-load-direct mode, introduced a few months back, was touted as a great step forward for the investors.
And now, there is this proposal to legitimise passback of commission, so they can legitimately get back some of the money their distributor earns. Also the investor may benefit.
But, that being the case, why are so many unit linked insurance plans (Ulips) being sold, where the first-year charges can be well over 70%? These schemes have so many charges, and are so well-packaged, that even people from financial services often fail to decipher them.
On top of it all, innovative handling of queries on charges and mis-selling are par for the course for insurance agents. After all, they earn double-digit commissions for a product that looks like a mutual fund scheme and offers insurance as an after thought.
Wouldn’t it be in the investors’ interest to be allowed to go direct in insurance plans, too? Clearly, that would allow them to save on a lot of costs. Also, unlike in MFs, one cannot change the agent easily in insurance.
When insurance companies are allowed a free run, why is the market regulator after the mutual fund industry? The question is pertinent because although these are competing products, there is no restriction on the charges on insurance.
Representations of the Association of Mutual Funds of India for a higher allowance of expenses to create a level playing field have been rebuffed. This is a problem with having multiple regulators rather than a single one for all financial services.
Given the disparity, MF distributors would gladly start selling Ulips, for they can earn a lot more there. The individual MF advisor earns 2-2.25% from selling MF schemes, on which he has to pay service tax, income tax and meet sales and operational costs. At the end, he may be left with barely 40% of the gross commission.
Intermediaries need to earn. An industry will remain healthy and vibrant only if the constituents are able to earn reasonable returns. Why else would be there in the first place?
But, clearly, the regulators do not think this applies to the mutual fund industry. Going by them, these players need to be controlled and disciplined as opposed to being just regulated. That’s a flawed premise.
Take the telecom industry. When it was government controlled, one had to register for a phone and wait endlessly. All that changed with the arrival of private operators and the ensuing competition. In a matter of years, the charges have come down from Rs 16 a minute to as low as 10 paise a minute.
This was achieved by creating an ecosystem with healthy competition, not by passing a diktat. Throttling the players with legislation would have killed what has grown into a vibrant industry and a major employer.
That’s precisely what the mutual funds industry needs, too. The regulator could look at other ways of deepening the market, broadening the reach and protecting investors’ interests.
The following constructive measures may be considered:
The regulator could look at ensuring that MF money stays invested longer, so people start participating in the growth story as investors, rather than buccaneers.
Introducing punitive exit loads, of say 5% for exits less than 12 months, could ensure that investors develop a long-term outlook, which is good for the industry and the economy at large. This will curb churning and ensure that investment in mutual funds is not 'hot money' that keeps moving in and out, such as those of the hedge funds.
This will bring stability in the market and give the fund manager the stability he needs to do his job properly, without constantly looking in the rear view mirror, for signs of redemption pressures.
Long-term investors can be incentivised. Lower expense ratios (of say, a maximum of 2.25% as opposed to 2.5%) for those staying invested for three years or more can be a tangible incentive.

Lastly, the anomalies should be corrected. When there were loads, the distributor was not expected to invest in his name and if he did, he had to inform that he was doing so to exclude those investments from commissions. Now that the no-load direct option is in, this system is redundant. Yet this continues.

It goes without a saying that equilibrium would eventually be reached, much like the toy I had. Only, whether it would be in the interests of the investor is another matter.