SEBI wants mutual fund commissions to be explicitly mentioned on account statements. As expected, the mutual fund industry is reluctant to!
Update: This has been officially announced. Circular on mutual funds (Mar 18th 2016)
It is the mutual fund investors right to understand how the NAV per unit of a mutual fund is calculated taking into account,
- trail commissions (applicable only for regular funds)
- Custodian fee, RTA fees, audit fees,
- AMC fees (profit) out of which some amount is given an upfront fee
- small amount towards investor awareness programs.
- upfront commissions and special commission or bonus incentives paid from the AMC fees
This could be incomplete/old because I don't know the full story, and as an investor, it is my right to know.
SEBI recognizes this and wants AMCs to disclose commissions paid to each distributor (this is variable, other components can be worked out from this).
Why is commission disclosure important?
Mutual fund distributors want us to think that there are only few bad apples in the barrel. "Not all of us are bad" is the common refrain.
Sure, not all of them are bad, but how do I tell the good guy from the bad guy? If I knew enough to answer that, I know enough to DIY.
That is the reason I keep saying invest in direct mutual funds and get professional but fee-only advice if required. Consider this extract from Value Research: AMFI Leashes Agent Commissions
In 2014, 111 equity diversified funds were launched, and amongst them 91 funds have declared their asset sizes. From these 91 funds, 61 are closed-ended funds. These closed-ended funds have also gathered more money than the open-ended funds. They have gathered Rs 13,154.36 crore as compared to the Rs 8,837 crore collected by the open-ended funds. This gives an impression that closed-ended funds are getting popular among investors. However, the reality is different ..
.. The reason closed-ended schemes are pushed hard is that distributors and agents get high upfront commissions for the investments made in closed-ended funds. Upfront commission is the commission which is paid by an asset management company to its agents in the first year of investment. It is paid by an AMC from its own kitty and it doesn't impact investors. As there was no cap on the upfront commission of distributors, AMCs doled out commissions as high as 8 per cent to their distributors for selling closed-ended schemes.
In order to check this practice of paying high upfront commissions and to stop mis-selling, from April 01, 2015, Association of Mutual Funds of India (Amfi) has put a cap on the upfront commission in mutual funds at 1 per cent. The trail commission will be decided by each fund house independently
If you think capping of upfront commission will stop this kind of selling, think again! The capping is not on commissions. Only upfront commission. The trail can be used to make up for it. So instead of getting the commission upfront, they will not get it in a staggered fashion.
The point is, we are hearing about these incidents after they have occurred. If the total commission/expenses are disclosed, it promotes and creates awareness. So I am not surprised there is opposition to disclosure!
It is the right of the investor to understand what they are getting into and why a product is being recommended.
The AMFI (association of mutual fund manufacturers) and the distributor community do not want this disclosed.
Why? Are they worried that regular mutual fund investors will switch to direct plans?
One article said, the commission listed on the account statement would be a 'distraction'! Read more: Regulator is making one fatal assumption'Distract' to direct plans I guess!
They claim that commission disclosure will induce pass-back! The mutual fund industry talks high and low about financial literacy because they want us to use mutual funds. However, they don't want us to know too much!
Why, because we will ask the mutual fund distributor to return some or all trail commission? This is a common enough practice in life insurance industry. Many (not all) clients ask the agent to pay first premium.
Will the same thing happen with mutual funds? Maybe, but everyone will do it! If a client does ask a mutual fund distributor to pass back the first year trail commission, it is plain innumeracy!
Life insurance product premiums decrease with time (with 1st year being the highest). Mutual fund commissions compound with time. So assuming the client does stay investing for many years (which is the main problem anyway), the 1st year commission should be relatively small unlike insurance .
So in my view citing 'pass-back' is only an excuse for not disclosing commissions. If anything, pass-back will not affect in-flows in any way!
The industry is saying they don't want to disclose facts to all investors because, 'some' investors will want pass-backs! How justified is that?!
Yes, passback is loss of some income, but is not the real fear the total loss of income due to the easy availability of direct plans and e-KYC if high commissions are revealed? The fear that HNI clients will go direct?
A smarter investor will switch to direct and not ask for pass-back!! S/he will save more that way!!
As Investors we have the right to say that commissions must be disclosed and that the SEBI recommendations should be implemented. Why?
Because It is a fact that many regular plan investors, especially those who invest via banks and online portal think they are using a 'free' account and not paying anything for services used.
Disclose commissions to eradicate this ignorance. If not all distributors are 'bad', then not all investors will ask for 'pass-back'.
Reluctance to disclose commissions only sends across the wrong message to the investor community. If you are a regular plan investor, this is yet another reason that you should choose direct plans!
DIY or seek an SEBI registered fee-only advisor to suggest direct plans. These plans can now be easily tracked by the advisor.
From the point of view the AMC, distributors are required for sustained profits. From the point of view of the investors, SEBI regulations and technological advances has ensured that intermediaries are not necessary. This is true if the regulations are rolled back due to a change of helm at SEBI.