Freedom of Choice

This is a column I recently wrote in Outlook Money 

Freedom of Choice

Variable loads will give MF investors more say, but it might be too much too soon

There’s a perennial joke I share with my neighbours, the Batliwalas, that whenever I advise them on mutual fund (MF) schemes, I don’t get any commission. Their agent gets it, the entire 2.25 per cent entry load that MFs pass on to agents as commission. And all for just providing them with the forms, or, at best, giving some advice that may not always be in their best interest. I may not get any commission, but thanks to a new proposal by the markets regulator, investors like the Batliwalas will now be able to decide how much commission their agent should get. 

After abolishing entry loads on direct investments in MFs in January 2008, the Securities and Exchange Board of India (Sebi) now wants to introduce variable entry loads. This means that investors will now decide the how much fees (0-6 per cent) they want to pay to their agents. Sebi aims to shift the pricing power from the MFs to the investor. Prima facie, this is good news. But with freedom comes responsibility. Are investors ready for this? 

The modus operandi. 

Sebi has given two options in its proposal. The first proposal says that the investor has to indicate the quantum of the load in the application form that he wishes to pay the agent, and the investor and the agent have to sign on the application form. The MF would then pay the commission to the agent out of the amount invested and issue units from the remaining balance. The other option is that the investor writes out two  separate cheques; one for the investment amount and the other for the agent’s commission that will go directly to the will give the agent’s cheque directly to the agent. 

Variable entry loads also seems to be the legalised version of rebating. Although Sebi had put a stop to this practice in 2001, it still continued. Now, instead of you paying 2.5 per cent commission to the agent and then getting him to give you a rebate, say, of 1 per cent, you will pay your agent that much less to start with. 

Which option is better? 

Of the two, the first option, in which the investor indicates the amount of load, makes sense. Already, filling out long application forms (more, if you are investing in multiple schemes) is a cumbersome exercise. Giving out two separate cheques will only add to the process. 

Lurking danger. 

Empowering the investor also comes with risks. For instance, in option two where the investor pays the agent and the fund house separately, there is a possibility of an agent misguiding the investor to give a commission that’s more than 7 per cent, the maximum entry load MFs can charge. Even 7 per cent is much higher than the present standards. Even in the first option, those investors who merely sign the application forms and leave the rest of the details to their agents to fill, will now have to ensure that the commission agreed upon jointly, is what actually goes on the form. 

What about insurance agents? 

Ultimately, no matter how many proactive steps Sebi takes to make MFs more consumer-friendly, unless similar discipline is enforced on the insurance industry, they will yield precious little. The commission of around 2.25 per cent that MFs pay brokers is dwarfed in front of the 20 per cent-plus commission that insurance agents get in the first three years of selling unit-linked insurance plans (Ulip). The insurance regulator seems to be in a coma and has taken baby steps to curb the evil. It’s not fair that of the two segments that are directly in competition for more assets, one is made to toe the line, while the other gets away with almost anything.