The concept of an entry load has been so abused over the past few years that the asset management industry in India has turned itself into an asset gathering industry. The money that you, as an investor, give to a fund house to invest in stock markets is partially diverted to compensate the distributor who got you into the fund. Your money is not earning you money but is used to fly someone to Bangkok for a holiday.

It does not end there. Once the investor is in the fund, the incentive to the distributor to keep him there exists — but it is a ‘small’ 0.5 per cent commission, known as ‘trail commission’. But that is not exciting enough for many aggressive distributors. Many of them make investors buy the next new fund on which they get that wonderful 5 per cent entry load as a commission. To put an end to these malpractices, Securities and Exchange Board of India (Sebi) has now proposed as an industry standard what Quantum Long Term Equity Fund did in March 2006: allow investors to invest in a mutual fund and not pay distributors any entry load.

The Sebi proposal is a diluted version of what the law should be but it is a small start. Not many investors come in directly — maybe less than 10 per cent. So there would be 90 per cent of investors who would still be ‘churned’ and dragged from fund A to B to C within one year, losing probably 10-15 per cent of their capital along the way. When markets are up, 30 per cent in a year, the loss due to that entry load gets hidden and disguised.

We cannot deny that there are distributors out there who do look after their clients and are focused on trying to build a portfolio of mutual funds that are best suited for their clients and these distributors deserve to get paid. The challenge is to educate investors that they should not speculate on which mutual fund will do well in six months (the justification for churning) but to stay invested for a longer period. And then to compensate the distributor via a balance reward structure which is transparent and fair to all.

One combination could be no entry load and, for those investors who wish to use distributors, a payment of a flat fee for their research and advice. When entry loads are removed — irrespective of whether the money comes in directly or via a distributor — the distributor is no longer focused on how he can make his client’s money jump from fund to fund to make money. His skills in understanding the needs of the client and building a portfolio of mutual funds will stand out, or be exposed.

At the end of the day, investors must recognise that regulators are there to build laws and frameworks but not to judge on ethics. We are clear that ethical business practices must always stay at our forefront and we are honoured that, as the 29th mutual fund house in the country, we had the courage to challenge the distribution system two years before the regulator decided to take the first step in what we believe is a necessary journey.

The writer is director, Quantum AMC