Having turned India’s mutual fund industry into one of the world’s cheapest for investors, the market regulator, the Securities and Exchange Board of India, made a reluctant about turn late last month.

At a recent board meeting, almost two years to the day after it abolished upfront fees on mutual funds, the capital market regulator announced that distributors would now be allowed to charge a Rs100 ($2.20) transaction fee for each fund subscription of Rs10,000 or more.

The move is aimed at helping the mutual fund industry attract more retail investors from small towns, says Sebi. It also announced proposals to regulate distributors with the help of asset management companies and to allow fund houses to launch retirement products.

“The Sebi move [on transaction fees] is in the right direction,” says Jaideep Bhattacharya, chief marketing officer of UTI Asset Management. “It might not add substantial value to the national or banking distributors. But it will definitely make a large impact on the small and medium-sized ISAs [independent service advisers].”

The announcements come as Sebi and the industry are seeking to arrest a decline in the number of people putting their savings into mutual funds and to encourage those who are investing to choose longer term plans.

Entry load was banned by previous Sebi head C.B. Bhave in August 2009, and since then there has been an exodus of nearly Rs200bn from equity funds while equity-oriented mutual fund accounts have fallen in number by 2.2m.

In the financial year
ending March 31, total assets under management fell 12 per cent compared with a year earlier, according to the Association
of Mutual Funds of India.

While sentiment has not been helped by volatility in global stock markets – India’s market has slumped to a 14-month low – most fund managers put the losses down to the restrictions on frontloading of fees. These fees used to be paid largely to the industry’s army of distributors, who would then eagerly generate more business for the funds. Now distributors have moved on to insurance-linked investment products (Ulips), which fall under a different regulator and are not subject to the same restrictions.

The introduction of the new transaction fee was welcomed by the industry. However, fund managers acknowledge that its low rate of only Rs100 per new subscription is still not enough to get most distributors excited, particularly when compared to Ulips, for which they are paid upfront commissions of between 6 per cent and 10 per cent of the first-year premium.

“Nothing can beat the commissions paid [for selling] Ulips,” says Jimmy Patel, chief executive of Quantum Asset Management Company.

Dhirendra Kumar, chief executive of Value Research, says the true aim of the new fee is not so much to act as an incentive for distributors but to cover their costs when serving small investors.

In smaller cities and rural areas where independent advisers dominate distribution, intermediaries are no longer able to earn enough from small investment subscriptions to cover the costs of meeting clients, manually filling in their forms and completing the transaction.

“The unintended consequence of the abolition of entry load was that the economics of serving small investors by a small intermediary completely disappeared,” says Mr Kumar.

UTI’s Mr Bhattacharya says he hopes the transaction fee will be sufficient to stimulate what is a crucial long-term market for the industry. In India, less than 2 per cent of the population participates in the capital markets. Investments in mutual funds from smaller cities also tend to be longer term in nature, or “stickier”, than those from the big metropolitan areas.

But while much of the focus from the Sebi meeting has been on the transaction fee, potentially more ground-breaking in the longer term is the prospect of mutual funds managers being able to launch retirement products.

“If you ask me, the next wave in the financial markets as far as mutual investors are concerned is going to be in the retirement space,” says Mr Bhattacharya. “The reason is that 87 per cent of the Indian workforce does not have a formal pension plan. At the same time our life expectancy has moved from the 50s and is now inching toward the 70s.”

The problem is that the details of any regulations governing these retirement products have yet to be announced. The industry will also face a challenge on how to create the right plans and fee structures to compete with the government’s ultra low cost programme, known as the New Pension System, which pays minimal fees.

The other important development was a move by Sebi to require mutual funds to conduct due diligence on their distributors and to disclose commissions paid to them. The regulator has not released details on how the managers will monitor distributors, leading many in the industry to see this as more of a learning process than a definitive measure.

“We feel that it should bring better clarity in the currently opaque world of distribution and its commissions,” says Quantum Asset Management Company’s Mr Patel.

Whatever the result of these measures, they will be critical to the long-term health of the mutual fund industry and ultimately, India’s capital markets. Fund managers say that only by better incentivising distributors and improving the quality of their services will the industry be able to achieve a market penetration more like that of developed countries.

“Mutual funds need to actively find a way in the next two years to add at least 100,000 more advisers to make penetration meaningful,” says Mr Bhattacharya.

Copyright The Financial Times Limited 2019. All rights reserved.

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