Mutual fund firms prepare for life without loads

The capital market regulator’s decision to scrap the entry fee on mutual funds from 1 August is set to alter the way the business is done in India, according to asset management companies and distributors that are now grappling with ways to deal with the looming change.

For one, while the move by the Securities and Exchange Board of India (Sebi) was meant to benefit the investor, the change does not necessarily mean a free lunch.

Distributors are devising ways to provide value-added services so that they can charge a fee for advising clients on financial goals instead of just hawking a product. A corollary to this could be that middlemen would focus only on high net worth individuals and wealthy clients, leaving the smallest consumers with no option to access fund services.

Secondly, the onus of getting the commission now passes from the asset management companies to the distributors themselves. Entry loads, which are capped at 2.25%, are typically passed on to the distributor by the asset managers. When a consumer invests Rs1 lakh, less than Rs98,000 is actually put in the fund. This is about to change now, as Sebi says that distributor fees should be paid in a separate transaction and the entire money that is given for investing should go into the fund.

On 1 July, Sebi said that funds may no longer charge an entry fee for a mutual fund scheme. It also tighetend the rules for exit loads, which are 1-5% of the assets under management. This amount is typically used to fund marketing expenses, a part of which is distributor commissions.

Now Sebi says that only up to 1% of exit fees can be used for marketing expenses.

“The pie is certainly smaller,” said Dhirendra Kumar, CEO of ValueResearch, a New Delhi-based mutual fund tracker. “We might even see distributors ask for more trail commissions.” Trail commissions are paid at the end of every year to distributors, and this is part of the expenses fee of the asset management company.

The Indian mutual fund industry has assets under management of Rs 6.7 trillion and about 87,000 registered agents sell mutual funds in India. These agents earned around Rs75 crore in the last financial year as entry load fees, according to a back-of-the-envelope calculation.

The previous year, one exceptionally good for equity inflows, saw them earning four times this amount. This is the money that Sebi has targeted.Some of the ideas that are floating ahead of the change in regulations include assets under management, or AUM-linked fee structures, where the distributor-turned-financial adviser gets a slice of the profits and bundling of services, especially by banks.

Some technology companies and the mutual funds business grouping, the Association of Mutual Funds in India, or AMFI, are introducing online platforms, which will help these financial agents aggregate data and provide better advisory services.

“It’s a new environment. People will have to move from distribution to advisory model,” said Jaideep Bhattacharya, chief marketing officer of UTI Asset Management Co. Ltd.

For that to happen, however, the army of distributors, most of whom just push mutual funds (as upfront fees make up the majority of their income), have to be trained. They have to have access to data and financial tools which will help them advise the customer on meeting financial goals.

This is where online platforms come in, said Rajesh Krishnamoorthy, managing director of iFast Financial India Pvt. Ltd.

Online platforms such as Fundsnet, iFast and Njfunds allow financial advisers to plug into and avail an array of services. These take care of the entire back office requirements of the distributors such as aggregating details of investments in various schemes and periodic statements besides offering them data and other investment advice, which can be used by financial advisers during their interactions with the clients.

“The writing is on the wall. The onus is on the distributors to create an ownership of customers by improving the quality of services. Platforms can be one way of doing it,” said Avinash Ramnath, national sales head of Canara Robeco Asset Management Ltd.

However, asset management companies cannot completely wash their hands of distributors either, cautions Sanjay Santhanam, who recently quit working as marketing head of Sundaram BNP Paribas Asset Management Co, and is starting a financial services firm.

“Mutual funds are dependent on distributors. And, when insurance agents work at double-digit commissions, and in a society where awareness about funds is low, it’s important not to throw the baby out with the bath water,” he said.

Upsetting equilibrium?

Mutual funds have traditionally griped about competition from unit linked insurance products or Ulips, that provide insurance cover and invest part of the premium in stocks and bonds. Life insurance firms do not have a standard method to calculate charges included in Ulips and as such distributors sometimes earn as much as 50% of the first premium as commission on these products.

Indeed some distributors such as Anagram Stock Broking Ltd say that they are now focusing on insurance.

“We are not going to sell MFs. For any product to be successful, there needs to be an equilibrium between distributor, consumer and the regulator. The latest Sebi ruling has upset this. Distribution cannot happen free,” said Sudeep K. Moitra, the company’s chief distribution officer.

Last financial year, Anagram said sold mutual funds worth Rs100 crore, of which 60% were retail transactions of less than Rs10,000 and Moitra says he couldn’t cover his costs with this.

If distributors turn financial advisers, then there is also a danger that they would marginalize small investors, especially those who are not literate or lack the savvy to log on to direct trading platforms.

“Those who are giving advice and who have been able to grow the investors’ money will continue to enjoy the confidence of investors, ” said N.N. Kamani, vice-president, marketing, Dhruv Mehta Investment Advisors, whose clientele is largely high net worth individuals.

From the asset management companies’ perspective, one way of dealing with the situation is to create an AUM-linked compensation structure with some big distributors. Thus, if a financial adviser-distributor helps a consumer grow assets by astute selection of mutual funds, the customer would pay him a slice of the profits. This is just another way for distributors to collect trail commissions, but directly from the consumers.

Changing investment norms

• What is an entry load?

This is the price an investor pays to buy a mutual fund (MF) unit. It is currently capped at 2.25% of investment. So, if one buys an MF unit for Rs100, only Rs97.75 is invested in the fund.

• Where does the balance Rs2.25 go?

A major part of this amount is paid to the distributor. Some fund houses use part of it to manage the fund, pay salaries of fund managers, meet administrative costs of sending monthly and annual return statements to investors and so on.

• Why is everybody talking about entry loads now?

They will be scrapped next month. Sebi has said investors can pay the distributor whatever they want as commission, but separately. This means that when one buys a mutual fund unit for Rs100, one invests Rs100 (and not Rs97.75).

• Does this mean investors will buy funds for free from August?

Not necessarily, but the agent commission may come down. The agents who normally hound investors to redeem money from existing funds and invest in new funds will not do that any more as they will no longer get upfront commission.From August, financial advisers will guide investors through a range of financial products. Indeed, they will charge fees for these services, but that’s a matter of negotiation between the investor and the adviser.

• What else does Sebi say?

Funds can use only 1% of exit loads for marketing expenses (even if they charge more).

• What is an exit load?

This is the price one pays for prematurely exiting the mutual fund. Asset managers charge 1-5% of investment (valued at current market prices) when one quits the fund. So, if the investment is valued at Rs100, at the time of premature redemption, one may get only Rs95.The penalty varies with the duration. So, the longer one stays invested, the smaller the exit load.

• If a fund is charging Rs5 as exit load but can take only Re1, what happens to the balance Rs4?

According to the new rules, the asset manager has to sink this into the fund. Following this, those who remain invested in the fund get the residual benefit of someone else’s investment.

Source: http://www.livemint.com/2009/07/22000123/Mutual-fund-firms-prepare-for.html

Index schemes the best way to secure the future?

Talk to a bunch of financial advisors about your retirement plans and chances are that some of them
would ask you to start investing immediately in a low cost index scheme to build your corpus. Lately, there has been a surge in number of financial advisors advocating index schemes as the best way to build nest eggs to take care of long term financial needs: be it your child's higher education abroad or your own sunset years. However, most of them concede investors still have a fascination for the actively-managed equity schemes vis-a-vis index schemes, which are a form of passive management. Index schemes don't take call on individual stocks; they simply invest in stocks that form the index-that too, in exactly the same weightage.
"As India becomes a more efficient market, fund managers would find it increasingly difficult to beat the indices consistently over a long period of time," says Gaurav Mashruwala, a certified financial planner (CFP). "If you look at the current trend, there would be schemes which may manage to outperfrom the index for a short while, but it may not do for a long period consistently. That is why you see constant changes in top performing schemes these days."
Mashruwala wants to know why one should pay extra to a fund manager when he is unable to beat the market benchmark on a consistent basis. "The whole idea behind giving a higher fund management fee in a actively managed fund is to get superior returns. But if it is not happening, then there is no point in paying a higher fee," argues Mashruwala. That is why many advisors like him believe investors would be able to make better returns from an index fund where the cost could be lower by 1-1.5%. "When you are speaking about a long term of 15 years, savings could be quite huge," says a wealth manager.
However, don't think the concept is universally accepted. Many investment experts as well as fund managers argue that they can still beat the market. "India is still an emerging market. We are nowhere near the US or other developed market where you have to really struggle to beat the market over a long period," says a fund manager. "If you look at the performance of actively managed schemes like diversified or large cap schemes outperform the indices in a period of 3-5 years." Critics cheekily point out the mutual fund disclaimer in reply: Past record doesn't guarantee future performance.
How does one choose the best index scheme from a plethora of schemes available in the market? "Investing in an index scheme may be a passive form of investment, but choosing one definitely is not something you should do casually," says the wealth manager. Mashruwala wants investors to place emphasis on the cost and the tracking error of these schemes before putting in the hard-earned money. Tracking error happens because the scheme may be keeping aside a part of its corpus in cash to face redemptions. Also, they may be buying shares through the day but the valuation may reflect only the closing prices. So it is important for an investor to review the performance of the index scheme for a medium to long period before putting in the money. If a scheme is trailing the index for a long period, it is best to avoid it.

Source: http://timesofindia.indiatimes.com/NEWS/Business/India-Business/Index-schemes-the-best-way-to-secure-the-future/articleshow/4809544.cms

Ulips cannot charge more than 3% as fee from Oct 1

Insurance Regulatory and Development Authority (Irda) on Wednesday stepped in to discipline life insurers and put an overall cap on all charges levied in unit-linked policies (Ulips) with effect from October 1 for new policies. In the case of existing policies the regulator has given life insurers time till December 31 to modify charges.Irda has capped overall charges at 3 per cent of net yield in case of Ulips with tenure of 10 years or below and fund management charge shall not exceed 1.5 per cent. Net yield is the return that customer gets on maturity minus charges. In case of insurance policies of above 10 years, Irda has capped total charges at 2.25 per cent, of which the fund management charges shall not exceed 1.25 per cent.Financial Chronicle in a front-page report on June 10 highlighted the huge charges levied by insurance companies in Ulips. These charges are much higher than those of mutual funds, where entry load has been brought down to zero per cent.The entire effect of charges will be reflected in net yield, which means a cap has been put on the amount that can be taken from customers under various charges. The insurance companies will have to restructure their products in such a way that they follow the required norm. About 40-50 per cent of the products available in the market will have to be overhauled.However, the companies have the freedom to structure the policies as they want to. Industry players feel that following this order, the companies will have to bring down the commission paid to their agents.“ Ulip products will see a decline in commission paid to agents. Companies will also have to look at expense management,” managing director and chief executive officer of IDBI Fortis Life Insurance G V Nageswara Rao said.Through this order Irda has also tried to encourage long-term investments.At present, the first year charges levied in a Ulip is as high as 60 per cent. While average fund management charge is between 1.5-2 per cent. Out of the total charges in first year about 35-40 per cent goes towards paying agent’s commission.Apart from capping charges, the regulator also mandates insurers to issue the policyholder a certificate at maturity showing year-wise contributions, charges deducted, fund value and final payment made to the policyholder taking into account partial withdrawals, if any.
“Irda through this circular mandates an overall cap on all charges put together. Care has been taken to enable the insurers freedom to distribute charges across the policy term in order to impart flexibility and facilitate product innovation,” said R Kannan, member, actuary, Irda in the order.However, insurers say that there is not enough clarity on the order. “Cap on charges is a step towards policyholder’s protection. But, there are many technical details which are not clear at this point of time", Rao said.“The circular puts expense management in focus. However, it is likely to drive Ulips more as an investment product than protection, thereby restricting the development of the protection industry", Rajesh Relan, managing director of MetLife Insurance Company Rajesh Relan said.TR Ramachandran, CEO & MD, Aviva India said, “With a cap on overall charges, the customers stand to benefit in the form of higher returns on their investment. Moreover, lower charges on products with a term greater than 10 years will provide further impetus to long-term policies.”Nitin Chopra, CEO, Bharti AXA Life Insurance Company said, “The cap on ULIP charges is a significant move for the Indian life insurance industry and its policyholders. This notification is a clear indication of Irda's focus on customer benefit and ensuring that life insurance products are easy to understand and buy. However, it would help if the mortality charges were removed from the overall ambit of charges, as mortality charges are dependent on individual customer profiles and the amount of cover required. ULIPs provide flexibility in choosing the sum assured. Hence, including mortality charges in the overall charge cap may adversely impact, especially the aged customers.”Rajesh Sud, chief executive officer and managing director, Max New York Life said, “Life insurance penetration in the country is low and distributors of life insurance need to be adequately trained and suitably compensated for providing quality of advice and service to the policyholders for the development of the industry. The capital requirement in life insurance business, both due to its large gestation period and due to the reserving and solvency requirements is far larger than other financial products. Hence, life insurance business should not be equated with other financial products and this capping of charges may reduce margins of life insurance companies.”

Source: http://www.mydigitalfc.com/insurance/ulips-cannot-charge-more-3-fee-oct-1-895

Ulips may fetch 150 bps more on new fee cap

Retail investors in unit-linked insurance plans (Ulips), arguably one of the hottest investment products, could see a 150-basis-point rise in returns.
The Insurance Regulatory and Development Authority (IRDA) has put a cap on charges that insurance companies, which sell Ulips, collect from investors. A slice of the charge is the commission paid to agents, which is set to drop.
IRDA’s decision is a fallout of a vehement attack on Ulips by mutual funds, which compete with insurers. Since mutual funds have to stick to ceilings on charges laid down by Sebi, fund houses felt they were at a serious disadvantage compared to insurance companies.
Ulip charges have been capped at 300 basis points for insurance contracts up to 10 years and 225 basis points for contracts over 10 years. If a fund earns a yearly return of 15%, a policyholder has to get a minimum return of 12%. The ceilings will come into force from October this year.
“The move will usher in greater transparency, making it a more attractive choice for customers. It will also bring in discipline in expenditure management by insurers,” said R Kannan, member, IRDA.
For contracts up to 10 years, the difference between gross yield and net yield (after netting out all charges) to the customer should not exceed 300 basis points. Of this, the fund management charges should not exceed 150 basis points, said IRDA. For insurance contracts of over 10 years, the difference between gross and net yields should not exceed 225 basis points. Of this, fund management charges will not exceed 125 basis points.
Currently, Ulip charges on an average work out to around 375 basis points. As most products have an average tenure of 13-15 years, the return to the policyholder could go up by 150 basis points.
But reactions were mixed from insurers. V Vaidyanathan, MD & CEO, ICICI Prudential Life, reckoned the move would benefit the industry in the long run. “Lower charges on products with a longer term will provide further impetus to long-term policies,” said TR Ramachandran, CEO & MD, Aviva India.
But the CEO of a private life insurance company deemed the move to fix caps as an exercise in futility. “A cap will not make a material difference as customers do not pay their premiums after the third year,” the CEO said. “We will have to examine the impact on all customer segments since the mortality charges are not uniform and vary with age. We would not like one segment of the customer subsidising the other,” said Rajesh Relan, MD, MetLife India Insurance Company.
Nitin Chopra, CEO, Bharti AXA Life Insurance Company, too said including mortality charges in the overall charge cap may adversely impact customers, especially those who are aged.
Source: http://economictimes.indiatimes.com/Personal-Finance/Insurance/Analysis/Ulips-may-fetch-150-bps-more-on-new-fee-cap/articleshow/4809946.cms