SEBI ends AMC malpractice in direct plans

Someone is sitting in the shade today because someone planted a tree long time ago.

Warren Buffet

Last time I wrote about how SEBI is making multiple changes to the investing framework to make investing more transparent and equitable for retail investors. I also bemoaned the general apathy of the retail investing community towards these changes which is the single biggest reason why these changes are not yet making the desired impact. It turns out however that the apathy of the investing community is so taken for granted by the AMCs that some of them have actually been taking rampant advantage of their ignorance and indifference to favor the distribution community, much to the displeasure of SEBI and definitely in contrary to the spirit of the SEBI guidelines. Here is how investors have been taken for a ride by these AMCs.

Remember how SEBI mandated AMCs to introduce direct plans in all schemes for the benefit of the retail investor who wanted to avoid distributor commissions. This was a very welcome move by SEBI intended to reduce the cost of investing for savvy investors or those who took the services of an advisor. Considering that AMCs pay between 75 to 125 bps as commission to distributors, the TER (total Expense ratio) of direct plans was expected to reduce in the same proportion compared to regular plans. However, would you believe that AMCs actually raised the fees in direct plans to compensate for revenue losses that they incurred in regular plans for having to reduce charges in those plans due to ceiling guidelines? Many leading business newspapers have reported on this prevailing malpractice which you may read on these links – Economic Times, Live Mint and Business Standard. This is a clear case of favoring distributors over investors by AMCs and a violation of their fiduciary responsibilities towards their Customers. It also contravenes the spirit of the ‘Mutual Fund Sahi Hai’ campaign that the MF industry has been promoting diligently for so long now.

Well, the good news is that this malpractice is set to end soon. Taking note of this malaise SEBI’s circular on transparency in TER of mutual fund schemes has directed that the difference between the TER of a direct plan and a regular plan should at least be equal to the distributor commission. In effect, it means that expenses towards distributor commissions should be booked in regular plans only – they cannot be booked in the direct plans. This guideline is expected to reduce the TER of direct plans in the coming months and investors should start getting notified about these changes from AMCs starting Jan 1 2019.

What to Do
This is yet another opportunity for investors to increase their returns from Mutual Funds by making the switch from Regular plans to Direct plans. The best way to do this is however is to review your financial goals with the help of a financial advisor and plan the switch in a manner that can best address those goals. A SEBI Registered Investment Adviser is best qualified to help you in this process.

SEBI bans upfront commissions to Mutual Fund distributors

Honesty is a very expensive gift. Don’t expect it from cheap people.

Warren Buffet

Last month SEBI asked Mutual Fund Asset Management companies (AMCs) to stop paying upfront commissions to distributors and instead adopt a full trail model of commission in all their schemes. This is a very admirable move by SEBI, to the large discomfort of a lot of distributors who had made a practice of earning extra income by churning their client’s portfolios frequently. Such upfront commissions were in the range of 1 to 1.5 percent and hence very lucrative to distributors. Each churn earned them an upfront commission from the AMC at the cost of the beleaguered client who was left to wonder why her MF investments were not delivering the expected returns.

This move by SEBI is the latest in a series of moves by the regulator in order to bring greater transparency to the Indian Mutual Fund industry for the benefit of retail investors. Some of these include:

• Removal of entry loads in all schemes of all funds
• Introduction of Direct plans in all schemes of all funds
• Capping of maximum Total expense Ratios
• Tapering of Total Expense Ratios by Assets under Management
• Mandatory disclosure of expense ratios by mutual funds for all schemes
• Mandatory disclosure of any and all changes in expense ratios to existing investors
• Standardization in the naming of mutual fund schemes to prevent confusion
• Mandating fund houses to use TRI (Total Return Index) v/s PRI (Price Return Index) for benchmarking performance of funds
• Introduction of the ‘riskometer’ – a five point scale from low to high – to enable investors better understand the risk associated with the fund.

The point of all this is to understand that the regulator is taking proactive steps and making changes to the investing framework to protect the interests of the small investor. Yet none of it will succeed if investors themselves choose to remain uninformed or uneducated about the benefit of these moves. Many a mutual fund investor has become so used to the prevailing system of investing via mutual fund distributors that they are averse to take advantage of the new framework even when it is in their own interest.

What to do

The simplest thing to do is to switch over from regular plans to direct plans of the same fund. The difference in expense ratio between a regular fund and a direct fund of the same scheme can be up to 1.0%, and when this difference is compounded say over the next 10 years, it can mean an additional return of more than 9%! In other words, if you have Rs 10 lakhs invested in a regular plan today, you can earn an additional 208,000 over the next 10 years just by moving to the Direct plan now (assuming a 8% return on the fund in the regular plan).

But hold on, just making a blind switch is not in your best interest, if only because it will lock you in for the next one year (remember exit loads). So if you are convinced about the need to make the switch you will be better off contacting a SEBI RIA to go over your financial plan and link your investment plan to your financial goals. Working in your best interest, your advisor will also recommend the best funds appropriate for your level of risk tolerance. And then suggest you to make the switch in a structured and tax efficient manner.

Why deal with a SEBI-RIA only?

When you combine ignorance and leverage, you get some pretty interesting results.

Warren Buffet

The investing community in India has witnessed a history of mis-selling of financial products. A recent example of this was the rampant selling of ULIP plans by private insurance companies and their agents prior to 2010. That round of mis-selling ULIPs was encouraged primarily by upfront commissions of more than 60% of first year premiums to the agents. Although this situation was corrected by the IRDA (the insurance regulator) in 2010 by tightening selling rules and introducing disclosures, the damage was already done by then as was discovered by a host of ULIP investors who found that they had been sold nothing but false promises!

SEBI (the capital markets regulator) got into the act in 2013 and introduced the concept of SEBI Registered Investment Advisers as part of the Investment Advisers Regulations 2013. SEBI also warned the general investing public to only deal with SEBI RIAs going forward. The press release in this regard is shown below.

Why deal with a SEBI RIA 

There are several good reasons for engaging the services of a SEBI–RIA for your financial planning and wealth management needs. The primary advantage for the client is that she is dealing with an investment adviser rather than an investment (product) seller. This distinction generates the following benefits:

• No conflict – Since the SEBI RIA charges fees directly from the client, he is free of conflict with product manufacturers and acts in the best interest of the client. He is also accountable to the client for this reason
• Certified – SEBI RIAs have to go through a stringent process prior to registration with SEBI. This includes passing the relevant NISM series X-A and X-B exams - which have negative marking - as well as demonstrating proof of adequate qualifications, capital and infrastructure. Moreover SEBI RIAs have to renew their qualifications every three years by clearing the NISM CPE exams in order to retain their SEBI registration. 
• Customized Advice – SEBI RIAs are required to tailor their advice to match the risk profile of the client. This guideline ensures that they do not dispense a one-size-fit-all solution to all clients.

What to do

It is amply clear that seeking financial advice from a SEBI-RIA is in the best interest of the investor. Astute investors should therefore first verify the credentials of their financial adviser from the SEBI website and thereafter compare their services and fees with other advisers. Investors should select an adviser who is not only qualified and registered but also credible and available. 

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