A ghost called no-loads has been haunting the mutual funds industry. Things have reached a panic situation as the September 12, 2007, deadline (the day after tomorrow), comes closer — the last day to send comments to the Securities and Exchange Board of India (Sebi) on its August 22, 2007, proposal to waive load for investors buying mutual funds directly from asset management companies (AMCs).What this means is, if an investor buys Rs 1 lakh worth of equity mutual fund units directly from its AMC, he won’t have to pay Rs 2,250 (it goes as high as Rs 6,000 for an NFO - new fund offer) as commission to some invisible distributor. The entire Rs 1 lakh will be invested and not Rs 97,750. Implications: roll that for 30 years at a compounded annual growth rate of 15 per cent and this investment grows to Rs 66,21,177 compared to Rs 64,72,201 in case he pays load — a difference of Rs 1,48,976. The moot point remains: why should an investor be forced to buy mutual funds through a distributor?In strictly off the record, long winded, exhausting conversations with lobbying heads of funds and distribution companies, I have learnt that issue is not restricted to intermediaries — foreign, Indian and state owned banks; large and small distribution houses; and of course, the individual agents. Of course, they will be affected as there will be a small migration, as aware small investors who see distribution houses merely using their portfolios to churn them from one new fund offer to another, switch to self-investing.But mutual funds are ‘product manufacturers’ who manage the money, why should they cry? The reason is simple: their 7-digit bonuses are dependent upon the distributor-based business model. It works something like this.• Let’s say a fund launches an equity scheme and distributors deliver Rs 5,000 crore of investments. If it’s an NFO, distributors can walk with Rs 300 crore (6 per cent of assets); if it’s an existing scheme, they get Rs 112.5 crore (2.25 per cent).• The fund gets to manage Rs 4,700-4,888 crore. On this sum, the fund, at an annual fee of 2 per cent on an average, gets around Rs 94-98 crore as income. On a net margin of say 30 per cent, the fund makes a net profit of Rs 28-29 crore.• Anything between 1-5 per cent of that profit, with staggered break-ups, goes to the top management as bonus. In this case, between Rs 28 lakh and Rs 1.5 crore.• Last year, the industry saw more than Rs 89,000 crore of equity schemes being sold, of which a little over Rs 22,000 crore came in as NFOs. Based on the assumptions above, the distributors took home about Rs 2,800 crore — Rs 1,500 crore from existing schemes and Rs 1,300 crore from NFOs.• The Rs 89,000 crore of new funds the AMCs got to manage would have earned the industry Rs 1,780 crore of new money, 30 per cent of which would be Rs 530 crore, of which Rs 5-25 crore would have gone into the pockets of executives as bonus.Not an insubstantial sum, if investors switch to no-loads. But the industry is working on the assumption that investors won’t switch, they will move away. Besides, if there is an existing business model working well, why upset it? This seems to be the logic behind AMC-intermediary nexus. What’s wrong in this is to get small investors to pay a commission even when they don’t use the services of a distributor.Large investors don’t pay loads — mutual funds have structured this product for small investors such that no load needs to be paid on an application of Rs 5 crore or more. The reason given is that it is cheaper to service one large application of Rs 5 crore than 1,000 smaller ones of Rs 50,000 each. But the same argument goes the other way when the financial sector offers its technology platforms to lower costs in banking, telecom, credit cards and so on. Only when it comes to mutual funds — and of course, the bigger gobbler of undeserved and opaque costs, insurance companies — does technology fail.In other words, small investors who have little or no voice and are generally too busy and financially illiterate to question commissions, should pay while large investors get to keep their cherries. The two-face I find most irritating is that the same people who want the government, the regulator, the non-profits — anyone but themselves — to encourage financial literacy, use that lack of information and knowledge to bat for distributors.“They serve a major function in analysing funds and giving advice,” a CEO of a large fund said. The head of a large intermediary firm is worried that the growth of mutual funds that has happened so far will stop once no-loads are introduced, as “We have helped expand the market by getting new investors. This expansion will stop once no-loads are here”.What do we finally want?In an attempt to stop no-loads from coming in, what I am afraid of is that industry representations will deliver a compromise: exclusive no load funds. That’s not going to help us. What we finally want: a no load option on each and every mutual fund scheme.Actually, no load funds is a future that has already happened. The option to offer no loads has been with the industry for many years now — the regulator has not mandated a ‘minimum’ load, only a ‘maximum’ one. Investors have been embracing mutual funds with a new confidence over the past three years, helping the industry grow to Rs 486,646 crore. But since it has not passed on the benefits of scale and growth to small investors, Sebi has had to intervene.What the industry needs to know is that the no-loads ghost will continue to haunt it until it becomes investor-centric and changes its business model, which among many other things means distributors becoming fee-based financial planners and advising/ selling no-loads.
