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None to Benefit From the New Disclosure Norms for Mutual Funds... - Outside View by PersonalFN

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None to Benefit From the New Disclosure Norms for Mutual Funds...
May 31, 2016

When you go to a grocery store, do you ask the shopkeeper what each product sold earns him? Would you care to know how much his staff earns? Thinking about the earnings of his suppliers and distributors wouldn't even occur to you. In fact, customers only worry about the quality of the products they buy and the price they pay. Full-stop.

If you agree with this, you will find new disclosure norms for mutual fund houses unnecessary.

Let's gets familiar with what has changed for mutual fund houses, distributors, and other intermediaries:

  • In a circular issued on March 18, 2016, the Securities and Exchange Board of India (SEBI) clarified that investors will get to know the amount of commission their distributor earned on their investments.
  • SEBI also made it mandatory for mutual fund houses to disclose the salaries of executives earning over Rs 60 lakh in a year.
  • With new regulations becoming applicable, the Consolidated Account Statement (CAS) will provide information on the expense ratio under the direct as well as a regular plan of each scheme the investor has invested in.

These regulations haven't gone down well with mutual funds and intermediaries. Mutual fund houses are denying easy access to the information about the pay packages of their employees. Some of them are insisting on legal undertakings that may add as a deterrent to those seeking information on salaries of the top brass.

On the other hand, mutual fund agents and distributors have been making representations to the industry body, Association of Mutual Funds in India (AMFI), expressing their disapproval to the newly introduced norms. Agents and brokers also opposed comparisons between the expense ratios of direct and regular plans in the CAS. They believe such policies are detrimental to the progress of the mutual fund industry.

Following this, AMFI decided to take this matter to the capital market regulator. The industry body has made it clear that no one in the industry or among the intermediaries could oppose the greater transparency. The only issue with excessive disclosure is-it may lead to malpractices. Mutual fund distributors believe the moment investors start seeing the money their advisors make, some might ask for kickbacks. The practice of passing commissions on is legally prohibited, but whether it is absent remains debatable. Similarly, if investors form a negative opinion about the mutual fund house based on the salaries it pays to key employees, talent retention will become an issue. As a suggestion on the alternative, the industry has shown its readiness to disclose the distributors' commission in terms of percentage.

Is SEBI going overboard with regulations?

Perhaps, it is. However, you should consider why SEBI might have taken such extreme steps.

Mutual fund houses preferred a commission-driven approach to expand their business for years. This led to moral hazards, and many distributors cheated their clients by churning their portfolios unnecessarily, selling them products they didn't need, concealing information about the risks involved in mutual fund investing and at worst, assuring them of high returns.

This is not to say that all distributors were alike or all those who followed this practice had ulterior motives. Many of them were novice advisors who wanted to do business, but didn't have enough knowledge and expertise to handle clients. As a result, investors were disheartened. Many first-time investors had horrendous experiences with mutual fund schemes; they weren't prepared to face losses.

PersonalFN believes, the regulator has a genuine intent to improve the disclosure norms to promote transparency in the mutual fund operations. But unfortunately, new rules have reached the other extreme. They serve little purpose in educating investors.

What may amaze you is there's no firm action against the mindless New Fund Offer (NFO) launches as yet. Mutual fund houses may disclose the commissions they paid to distributors, but how can investors be sure that intermediaries have sold them relevant products? Through these changes, though the investors may know about salaries and other perks of fund managers and key personnel earn, what on the earth would justify whether the fund managers deserve (or don't deserve) such fat pay packages?

If SEBI's intends to discourage the distributors' route, it's acceptable; but how will it ensure that Indian investors are mature enough to make wise financial decisions?

Hence PersonalFN believes investors need to be educated first. Instead of imposing new norms frequently, to strengthen the process, the regulator could try and create a predictable environment. Today, less than 10% Indians invest in mutual funds. So you can easily guess what the real potential of the market could be. Despite these macros, mutual fund houses have been exiting relentlessly. Why? It is up to the regulator to figure out answers to such tough questions.

Commissions, per se, are not evil, but the strategy to earn commissions without caring about the investors' interest certainly is. Keeping aside all fears, if one analyses the situation today, it seems the regulator is equally hesitant to take strong action against "copy-pasted" NFOs; and mutual fund houses too are afraid to protest openly against what they think is wrong. If they agree with the disclosures, why are they blocking the flow of information?

The mutual fund industry certainly needs prudent regulations safeguarding investors; but the regulator also needs to ensure that the future of the Indian mutual fund industry is not imperilled, and morale of the fraternity is not pared.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


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