Sebi's good intentions crippled the Great Indian Mutual Fund

On August 1, 2009, nearly a year back, the Securities and Exchange Board of India (Sebi), the stock market regulator, banned mutual funds from charging entry loads.

Mutual funds used to typically charge an entry load of 2.25% of the net asset value of a schemeand use that money to pay agent commissions.

In the new regime Sebi wanted the agent and the investor to negotiate and arrive at a commission, which the investor could pay the agent by issuing a separate cheque.

At least that was the plan.

While this made it cheaper for retail investors to buy mutual funds, the fall in commissions for its agents and distributors effectively left few people to sell it to them.

Now nearly one year on, the effects continue to be felt. “The situation is still difficult. We are still seeing net redemptions,” said the head of a mid-sized mutual fund.

Assets under management for equity funds, which have the most amount of retail participation among the various segments have seen net redemptions in 8 out of 11 months since the ban on entry loads.

There have been net outflows of Rs 8,160 crore since August 2009 in case of equity mutual funds.

As one industry person said, unlike other products such as toothpaste or toilet paper nobody wakes up in the morning and feels a pressing need to buy a mutual fund.

The Ulip conundrum

With insurance products offering higher commissions, distributors are said to have dropped the mutual fund in lieu of a more expensive investment product-the unit linked insurance plan, whichis an investment plan with a dash of insurance.

Ulips have been paying significantly higher commissions than mutual funds over the years, though structurally they are more or less the same.

Between July 2009 and March 2010, for which the latest data was available, Ulips managed to raise Rs 108,803 crore in total. That clearly illustrates the power of commission in a country, which is gradually coming out of financial illiteracy.

There was an attempt to bring parity between Ulips and mutual funds when Sebi issued a circular asking Ulips to register with Sebi, but an ordinance that placed control definitively in the hands of the insurance regulator (Irda) and away from the hands of the market regulator put paid to a glimmer of hope for mutual funds.

Fund houses grappling with changes are said to be finding it difficult to engage the customer, said industry insiders.

“The change was brought about too fast, business models need time to re-align. As a result, engagement with end customer has gone down because everybody is focused internally,” said the head of a foreign mutual fund.

What also does not help is the fact that insurance companies are allowed to use celebrities to advertise while mutual funds are not.

So you have the likes of Sachin Tendulkar, Virender Sehwag and even super star Amitabh Bachchan advertising insurance. “Now how do you expect us to take on a me too product being advertised by Amitabh Bachchan, our superior performance not withstanding?” asks the head of sales of a mid sized mutual fund.

Long-term Ulips?

Insurers have often stressed on the fact that Ulips are a long term product. In fact that claim also falls flat in lieu of the fact that over a period of five years, the average return of an equity mutual fund has beaten the average return of equity oriented Ulips by more than 20%.

The 25 best mutual funds on the other hand have given an absolute return of more than 80% in comparison to equity oriented Ulips.

Effective competition is supposed to act in the best interest of the consumers. But that does not seem to be happening in the context of the retail investor in India who can choose between the high commission paying Ulips and very low commission paying mutual funds.

The obvious reason as explained above is there are perverse incentives at work. But the truth is a little more complicated than that.

Let’s deviate a little into an interesting example that Sheena Iyengar gives in her book The Art of Choosing about bottled water brands.

“The two best-selling brands of bottled water in the U.S. are owned by Pepsi (Aquafina) and Coke (Dasani), you’d be... unlikely to see them aggressively advertising their health benefits relative to soft drinks, one of the few they could legitimately make.”

The moral of the story: A bottled water brand cannot say it is healthy to drink water if it happens to be owned by a company which also sells soft drinks.

Similar is the case with the Indian mutual fund industry. Not one mutual fund till date has made an effort to communicate its better performance over Ulips in the last five years. Not one mutual fund has made an effort to communicate its low commissions vis a vis Ulips.

If one side of the market cannot communicate what its strengths are then there is no way a market can function efficiently and people of course will continue to buy high commission paying Ulips.

And why is that? The biggest Indian mutual funds are all promoted by companies which have insurance subsidiaries. Be it Reliance, Birla, SBI, ICICI, HDFC, Kotak, Religare Bharti Axa, ING, Tata, HSBC, Canara or LIC.

All these promoters run both insurance companies as well mutual funds. So there is no way any of the mutual funds can come out and compare their performance with Ulips and say their performance is better. It is not in the interest of their promoters.

Over and above that some of these promoters also run banks.

And for banks, insurance commissions are lucrative and an easy way of boosting their other income.

In fact a recent survey titled the “India Bancassurance Benchmarking Survey 2010”, carried out by Rajagopalan Krishnamurthy of Towers Watson points out: “The responses to the survey confirm the assessment that bank distribution in the case of life insurance is currently highly skewed in favour of Ulips.

Ulip sales account for more than 85% of premiums generated by banks.”And since collecting these premiums pays high commissions, banks like to sell only Ulips.

So basically it’s not in the interest of any of the players in the market to disturb the current high commission paying set up. And you my dear investor are the least of their considerations.

The regulator’s perspective

The chairman of Sebi, C B Bhave expressed the regulator’s perspective at a mutual fund summit in June, saying that the regulator will prefer to put the investor before the industry.

The assets under management for the industry currently stands at Rs 6.75 lakh crore with Income funds accounting for Rs 3.28 lakh crore. The huge amount of money in income funds points out clearly to the oft repeated fact that the Indian mutual fund industry caters primarily to institutional investors.

There have been other attempts by the regulator to make the

mutual fund more “retail investor” friendly.

Recently Sebi has tried to bring in parity in the expenses charged to institutional and retail investors. Large institutional clients would be charged much lesser for their investments in debt funds

compared to retail clients. This, argued the regulator, amounts to the retail investor subsidising the institutional one.

Fund houses are said to have protested on the ground that the cost of servicing a retail investor too, is different from that of an institutional client.

Sale of mutual funds through exchanges began after Sebi’s November 13, 2009, circular stating that mutual fund schemes may be permitted to be transacted through registered stock brokers of recognised stock exchanges.

Despite points of presence inacross India, the initiative has so far failed to take off.On average, there have been 1,032 trades daily for the month of July, less even than one for every one of the 1500 cities that just the National Stock Exchange boasts a presence in.

A number of other mutual funds are also reportedly looking for banking partners to strengthen their distribution.

Some in the mid-sized segment are looking at selling a stake including one that is fond of gerunds and another which had tied up with a company known for its telecom operations.

Consolidation may not take place through acquisitions or mergers. “Consolidation in terms of AUMcould happen with more of the money going towards fewer of the players,” said the head of one of the largest AMCs.

Meanwhile, for many other mutual funds the ending does not seem as happy.

One mutual fund chief executive officer summed it up, late one night, after the passing of the ordinance which placed Ulips outside Sebi’s purview. “We are dying.”

Source: http://www.dnaindia.com/money/report_sebi-s-good-intentions-crippled-the-great-indian-mutual-fund_1415133-all