Waive entry load across the board

Most equity mutual funds charge retail investors an entry load of 2.25% on all their investments. This entry load is mandatorily payable irrespective of an investor’s mode of entry.

As per the Securities and Exchange Board of India’s stipulations, the total amount collected as load for each scheme has to be maintained in a separate account by AMCs and can be utilised towards meeting selling and distribution expenses. As per industry practice, the load is utilised for paying the agent/distributor’s commission.

This raises the moot question — should investors applying directly to the AMC through the internet or even by submitting their forms to the AMC’s collection centre be charged the entry load?

In other words, why should investors who do not avail of the services of the agent or distributor be made to pay a fee that is ultimately pocketed by the middlemen? Hence, keeping in view investors’ interest, Sebi is considering giving a waiver in entry load for direct applications received by the AMCs.

The regulator had invited comments on this issue on or before September 12, 2007. Though the date has passed, a discussion is still very pertinent.

Over the years, Sebi has been doing an excellent job of regulating the MF industry and making it adopt international best practices as far as possible. The plan of the waiver of load is a welcome step that will no doubt benefit the small but informed investor.

However, when I try and look beyond the obvious, I find certain creases that may need to be ironed before implementing this move, which helps a small minority access a cheaper product that a vast majority has little knowledge of.

While providing the indformed investor with choice is a desirable objective, protection of the interest of the uninformed investor is critical.

First and foremost, would it be appropriate if the waiver were to be made applicable to MFs in isolation? There are other investment products which for all practical purposes are MFs, only not called so.

Take for example the unit linked insurance plans (Ulips) of insurance companies. These are nothing but MFs that charge far higher loads (from 15% to 75%). Of course, the charges come down over the tenure of the investment, but that still doesn’t wish them away. Moreover, the way Ulips are being promoted, it is difficult for an uninformed investor to differentiate and tell apart an MF from an Ulip.

Then, there are structured products issued by portfolio managers, which, too, are nothing but MFs that offer substantially higher fees to distributors.

In such an environment, where products with similar functions co-exist, albeit with a vastly dissimilar incentive structure, there is bound to be wholesale shepherding and forced migration of uninformed investors to such products. In other words, there is a clear and present danger that the MF industry will end up subsidising competing investment products.

This is not to say that the load should not be waived. Definitely it should. However, it should be done across the board, and not selectively. Admittedly, this is easier said than done as the regulators of both industries (Sebi and IRDA, respectively) differ.

However, if any practice is deemed desirable, it should be implemented notwithstanding the industry concerned. An effort must first be made by the respective regulator to impose the best practices in respect of their products uniformly.

Secondly, the three affected parties basically are MFs, distributors and investors informed and uninformed. Though the immediate interests of each of these constituents may differ, they do indeed have a common objective — that of growth and development of the MF industry.

The more the industry grows, the better the technology and skilled manpower that AMCs can afford, thereby engendering more competition and better returns to investors.

However, if the pipe at the beginning is made narrower, other (quasi) MFs will take over the market to the detriment of the uniformed investor.

It is only in a perfect world that the uninformed investor will pay the load for the advice and service he is getting. More often than not, the uniformed investor is uninformed about the fact that he is uninformed.

If a lower load is available within the same scheme, he will want to avail of it and eventually this will lead to load shopping with distributors undercutting just to get additional business.

That said, I cannot emphasise enough that a knowledgeable investor is forced to pay someone for services he doesn’t need. For such persons, dedicated no-load schemes should be offered — in fact, it could be made mandatory for MFs to operate no-load schemes for each category of products.

The only submission is that imputing zero or variable loads across the board in existing schemes will confuse and corrupt the market. A scheme should be either with a load or without.

To sum

As a consumer, I, too, look forward to cheaper financial products. However, I hope the authorities come to a decision after careful consideration of issues such as those laid out here. For, as an informed investor, I don’t want to end up saving two but paying twenty.

sandeep.shanbhag@gmail.com