Retention, not exit, will help fund houses

The already-struggling mutual fund industry has a new headache. According to the Securities and Exchange Board of India’s latest guidelines, the exit load that fund houses charge will be ploughed back into the scheme, and not to the balance sheet, as was done earlier.

This, on one hand, will improve the net asset values for investors who stay in the scheme. But fund houses’ balance sheets will lose out on one component of income.

While details of the guidelines are yet to be notified, industry players are already talking about reducing upfront fees to ensure there isn’t an adverse impact on their profit and loss accounts.

What will, of course, help them is the rise in the total expense ratio by 20 basis points, and an additional 30 basis points if the incremental increase in assets is from smaller cities.

According to the chief marketing officer of a large fund house, the net impact will be marginal but that can be taken care of, if industry adopts the new business model to bring down upfront commissions.

The exit load was meant as a deterrent for investors so that they did not leave the scheme in less than a year, in case of equities. Normally, one to two per cent is imposed based on the tenure of investment. “But exit of investors before investment duration also benefited AMCs as they used to get exit load amount besides helping distributors make money because of the churning,” he further explains.

“Though prima facie it appears that this arrangement of routing the exit load back to schemes may impact us. But since, the regulator has allowed us to charge extra 20 basis points and shifted the service tax out of the total expense ratio the impact will lessen,” says the chief executive officer (CEO) of a small-sized fund house who did not wish to be named. Already, only 15 out of 44 players made profits in 2011-12. Of this, four houses had profits of less than Rs 10 crore.

Fund houses have a bigger dilemma – whether to reward entry into schemes through an upfront commission or hike the trail commission to reward staying invested for a longer time.

“In today’s context, if I pay high upfront commission, what’s the guarantee that investors will remain with me. And, in case he moves out within a year, exit load collected will go to schemes and not the AMCs. So, I would lose the upfront as well as the exit load. Rather, I would increase trail commissions and reduce or phase out upfront fees,” added the CEO.

Most of the chief executives echoed this. Moreover, this kind of probable strategy is also in line with what majority of independent financial advisors (IFAs) want. If trail goes up, distributors will be encouraged to retain and service their clients for longer duration benefitting all stakeholders of the industry. Currently, on an average upfront fee ranges from 10 bps to 50 bps while trail commission is around 30-80 bps.

According to independent industry experts, large fund houses may not find it difficult to continue with higher up-front payouts as they are relatively better placed than smaller fund houses and new entrants in the fund management business.

In FY12, overall commission payouts to mutual fund distributors were 5 per cent higher at Rs 1,860 crore against Rs 1,770 crore in FY11.

Source: http://www.business-standard.com/india/news/retention-not-exit-will-help-fund-houses-/484834/