Impact of No Entry Load Regulation on Distributors of Mutual Fund Scbemes In

Bareilly
Background
The Indian Mutual Fund (MF) industry has witnessed one oI its major transIormations
Irom August 1, as the ban on entry load investments in all MF schemes imposed by the market
regulator Securities and Exchange Board oI India (SEBI) comes into eIIect. SEBI has
instructed that mutual Iunds cannot levy any entry charges Ior investments but
allowed distributors to claim a Iee Ior their advice Irom investors. It also directed them to
disclose commissions earned to clients.
Changing regulations is not a new trend in the mutual Iund industry; we have had
previous rulings which seemed diIIicult and cumbersome to implement at the time but have been
adopted by all aIIected parties over time. In 2001, SEBI made AMFI (Association oI Mutual
Funds in India) certiIication compulsory to sell Mutual Funds which were accepted aIter initial
protest Irom distributors. Similarly, a PAN (Permanent Account Number) was made compulsory
Ior all Mutual Fund investments in 2007 and KYC (Know Your Customer) compliance was
made mandatory last year. In spite oI all the objections, over time everyone has accepted the
changes, adapted to them and moved on.
oncept of Entry Load
'Entry Load is an upIront charge levied by Iund houses when you invest in various MF
schemes. This load used to vary Irom 0 to 2.5. This load was charged (supposedly) to
compensate the MF houses Ior marketing and distribution costs. The charging oI entry
load resulted in less oI investor`s money being invested in an MF scheme. For example : II
you invest Rs. 5,000 every month in a MF scheme; and iI there is an entry load 2, Rs. 100
would be deducted upIront Irom your investment. That is, instead oI the Iull Rs.5, 000, only Rs.
4,900 is actually invested in the Iund.
Reasons behind entry load ban
For some time now, there have been mounting complaints oI blatant mis-selling and
portIolio churn happening in mutual Iund distribution. In many quarters oI the market, mutual
Iunds are apparently sold not on the basis oI the investor`s needs and requirements but on the
basis oI commission being paid. Again investors have been complaining oI poor or virtually no
service being rendered by some distributor's leading to an unhappy Ieeling amongst a section oI
investors. These serious issues warrant the regulators attention.
IMPA% OF EN%RY LOAD BAN
SEBI`s move to ban entry Iees Ior investments into mutual Iunds will lead to a jump in
long-term inIlows as distributors adjust their business models to generate more volume and trail
Iees (recurring Iee paid to the distributor).
Positive result of this move
According to analysts, 'This is one oI the most signiIicant changes that the mutual
Iunds industry has seen in recent times. It is a positive move Ior the beneIit oI
the investor community, Ior the beneIit oI regulation and Ior the transparency oI
the mutual Iunds industry.
It would reap a host oI benefits to the investors such as:
Higher returns Ior the same investment- ulsLrlbuLors wlll geL a fee for Lhelr advlce and hence
dlsLrlbuLors wlll be forced Lo glve Lhe rlghL advlce raLher Lhan promoLlng schemes whlch offer Lhem superlor
brokerage commlsslons
art|cu|ars W|th Lntry Load W|thout Lntry Load
lnvesLmenL 8s 100000 8s 100000
LnLry Load 223 nll
neL AmounL lnvesLed 8s 97730 8s 100000
Average reLurn over 10 years 12 12
lnvesLmenL value afLer 10 years 8s 303397 8s 310384

Lower advice to churn your portIolio- no more churnlng of lnvesLors' porLfollos whlch many
dlsLrlbuLors used Lo lndulge ln especlally when a new lund Cffer (nlC) would be announced Lo earn hefLy
commlsslons wlLhouL any care for your money
Improvement in quality oI service due to Iee-based advisory services- lncrease ln demand
for professlonal advlce would lncrease compeLlLlon ln Lhe advlsory buslness and lmprove Lhe quallLy of lnvesLmenL
advlce offered Lhereby beneflLlng lnvesLors CerLlflcaLlon wlll become lncreaslngly lmporLanL ln Lhe advlsory
buslness whlch would mean more regulaLlons Lo proLecL consumers sLandardlzaLlon of advlce across Lhe board
Lesser New Fund OIIers (NFOs)
Change in the attitude oI investors 1he relaLlonshlp beLween Lhe advlsor and lnvesLor becomes
more processdrlven and cusLomercenLrlc raLher Lhan LransacLlonbased
several sLraLegles LhaL can aLLracL lnvesLors afLer AugusL 1
O LargeLlng Pnls along wlLh reLall lnvesLors


IMPA% ON DIS%RIBU%ORS
The ban on entry loads the 2.25-2.5 per cent Iee mutual Iunds charge investors on
schemes, which is used by money managers to pay distribution commissions is seen by insiders
as a paradigm-shiIt reIorm Ior the Indian market. This move by SEBI will have major impact on
distributors and the Independent Financial Advisors (IFAs), as their margins are likely to take a
major blow. But several Iund houses have already started to promise an upIront commission oI
2 to the distributors. Sabapathy Iyer, CEO oI JR Laddha Financial, a distribution house, in
Mumbai said, 'How long are the Iund houses going to pay the upIront commission? In the long
run, only those who provide better service to the investor and have maintained a cordial
relationship with their investors will survive.
The ban is expected to have a big impact on the way distributors take care oI their clients.
'What has been happening until now is that once a distributor sold a Iund he Iorgot about the
investor. Now he will have to continue to be in touch with the investor, providing
real services, so that the investor Ieels obliged to pay the distributor.
'Clearly there will be a reduction in business and activity will slow down. The ban will
change the intermediation that existed earlier, because oI the revenue pool that Iund managers
and distributors work on and which they share between themselves will be reduced Irom August
1 onwards."It will discourage unnecessary NFOs (new Iund oIIers) because what was
happening is a distributor who was earning 2.5 percent commission was interested in churning
people Irom one scheme to the other just to make sure he makes his commission,"
As per data compiled by the Association oI Mutual Funds in India (AMFI), More than
halI oI the 1.2 trillion rupees equity assets oI the Iunds industry was less than two years old at the
end oI March, 2009` as a result oI Irequent churning. This is set to change now as distributors,
who get an upIront Iee Irom about 2.5 percent entry load that equity Iunds charge will now have
no interest in making investors switch Iunds. Instead, they stand to gain more in the Iorm oI trail
Iees or the money they get Irom Iund houses on continuous basis, iI investors kept the money
invested longer.
'Distributors will evolve an advisory Iee model and will also get remuneration Irom Iund
houses Ior distributing products either in terms oI upIront or increased trail, While the changes
will hurt distributors revenues in the short-term and limit Iund Iirms ability to gather assets in
new Iunds by paying large upIront commissions out oI entry Iee, it make investing cheaper and
more transparent Ior investors. A distributor "would be more interested to keep his trail alive,"
Abizer Diwanji, head oI Iinancial services at consultant KPMG said.
The ban is also likely to have a negative impact on India`s $137bn (t96.4bn, 86.2bn)
mutual Iund market, because distributors will have less oI an incentive to promote new products
oIIered by the mutual Iunds. 'In the short term there will be disruption to business, as
distributors will try to Iind other products that reward them better,
Fund managers also Iear that, in the short term, they may Iace growing competition
Irom insurance and pension Iunds, since distributors are likely to market more products similar
to mutual Iunds that have not been hit by the entry load ban.
However, over the medium to long term, Iund houses and distributors are expected to
revamp their business models and will look Ior new pay-out structures, according to Sukumar
Rajah, chieI inIormation oIIicer at Franklin Templeton India. Mr. Kumar oI IDFC
believes that the short-term Iall in product launches Irom August 1 onwards could be
compensated Ior by a strong market perIormance and more active mutual Iund investors. 'Most
investors believe the rule change is a good move; it will make investors a bit more proactive.
IMPA% ON EMPLOYMEN% OPPOR%UNI%Y
The asset management industry does not invest directly in building a large sales Iorce
to market and sell its Iunds to investors. Third party distributors are very important. Mutual Fund
companies will continue to Iocus on selling products through its distribution partners as they Iind
it diIIicult to envisage Iunds taking their products directly to clients. The awareness oI Iunds is
not very high, and the average retail client is not very comIortable deciding Irom the vast array
oI choices.
Currently there are only 75,000 AMFI certiIied agents in the country which is very low
Ior a country India`s size. That entails a lot oI education and investment; the low margins oI the
industry are not allowing it to make that investment. This scenario gives a wide range oI
employment opportunity as Asset Management
Companies (AMCs) would now look to employ people directly Ior marketing and selling
their Mutual Funds to the investors. On the other hand, it is also likely that Distributors
would now employ less sales Iorce to market and sell Iunds as there is no margin Ior them.
There are various distributors in the market who employed such people, who might have to bear
the brunt oI this entry load waiver. AMCs might plan to deploy its own task Iorce but they would
mostly be highly-skilled as against Distributors who employed lower-skilled Iorce with the
capability to just 'market and 'sell. However, AMCs would not be able to match up with the
competency and penetration level oI the Distributors.
ONLUSION
The Iixed entry load structure Iollowed earlier, had an embedded conIlict oI interest
Ior distributors. As distributors made a Iixed sum on mutual Iunds notwithstanding their
perIormance, they had an incentive to push MF schemes, even iI the investor did not require it.
This led to constant churning across schemes and hindered long-term asset
creation. ThereIore, it is appropriate that SEBI is putting an end to this practice. In the new
scheme oI things, the investor will pay a Iee to distributors and has the option to negotiate it
based on the quality oI the service provided.
In a nutshell, the new regulation will lead to long-term asset creation. However, there is
no clarity on whether investors or AMCs will be paying commission to distributors. A majority
oI retail investors do not have the tools to Iind appropriate inIormation about Iinancial products.
ThereIore, it seems that they are not on an equal Iooting with distributors. The latest move might
complicate matters, as it expects the investor to negotiate with distributors on their own.
Investors should be really cautious, especially iI the distributor seems overeager to sell ULIP
products.
To conclude, Paul Samuelson, winner oI the Nobel Prize in Economics rightly said: 'A
small man anyone with a portIolio oI, say, under $100,000 is unlikely to do as well investing
his own money as he can do in a no-load Iund.