Friday, February 15, 2008

Not Quite There, Yet

MFs are now transparent and cheaper, but agents will now push Ulips harder

Part of the privileges I should enjoy by tracking mutual funds (MF) for so long is to avoid paying agent fees, isn’t it? After all, why should I pay the agent just because he gets me a form, when I decide on the funds that I should buy. My wish finally came true when, effective 4 January 2008, the Securities and Exchange Board of India (Sebi) abolished entry loads for direct MF investments. On 31 January, Sebi banned closed-end MFs to charge and later amortise initial issue expenses on the back of an NFO fever that saw 42 closed-end schemes— as against 34 open-ended ones— launched since amortisation in open-ended schemes was banned on 4 April 2006. Prima facie, informed investors and Outlook Money readers benefit as we already shortlist schemes for you.

Should agents be avoided then?
No. The uninformed investor still needs the agent’s help. The reality is that MFs need agents to grow. At present, MFs don’t have the required infrastructure to handle masses of investors. Setting up infrastructure is a costly affair that only big-pocket players can afford. Urban investors can invest through the Internet, but penetration is limited in rural areas. It is here that agents can play a vital role in mobilising collections.

Problems
The agents are upset. When amortisation was allowed, they were spoilt with a 5-6 per cent commission from MFs to sell their NFOs. Foreign trips came about once in two-three months at the expense of the investor. Further, with unit-linked insurance plans (Ulips) offering 10 to 25 per cent commission in the first year itself, agents are tempted to push Ulips. Sources say that on the back of Sebi moves, this has already started happening.

Sebi’s moves have also encouraged passbacks. As agents get trail commissions of around 40 to 60 basis points, some of them have started to return the 2.25 per cent entry load to the investor. This way, both the investor and the agent are happy. Remember, passbacks make sense when a planner sells you a product since he recovers his cost through the fee. and he needs to be the passthrough to service the client.

Solution
There’s a four-point solution to the mess:
Sebi should encourage a variable load structure, wherein investors and agents could negotiate and decide how much commission the agent should get. At present, discount brokers (agents that only give forms and little or nil advice) as well as financial planners get identical commission even if the latter does the planning. If fees could be negotiated—anything between nil and 2.25 per cent, and not just either of the two, as is at present—both parties would be satisfied.

This would also encourage serious financial planners. Agents, after all, have had it very good so far and it’s time that the freebies stop. This really means legalising passbacks, that incidentally are allowed in the mature markets.

MFs need to find a way to increase trail commissions on existing schemes once they complete three years to avoid churning and give credence to performance. Ulips, too, should have a similar approach. The insurance industry might justify higher costs saying it is growing; the reality is that most Ulips are mis-sold and the industry is growing in a wrong way. The industry is now hiding costs inside the product.

Sebi should expedite its financial intermediary guidelines and ensure that all types of agents selling all kinds of financial products are governed and made accountable for their actions.

Ultimately, all regulators—Sebi, Reserve Bank of India, Insurance Regulatory and Development Authority and even Pension Fund Regulatory and Development Authority—must sit together on a continuous basis. They should ensure that an equitable cost structure is arrived at across investment vehicles so that none is over- or under-regulated.

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