The regulatory diktat of abolishing entry fee for mutual funds has received a good coverage in the financial media and blogosphere. Almost in all of the news coverage, it has been hailed as a beneficial to individual investors. Many financial and personal bloggers have also published individual post explaining how and why it will be good for individual investors. This was a typical example of herd mentality – everybody saying good so it is good. I am surprised that personal finance folks are also providing one sided opinion.
I found only one article by Shewta at Personal Money which provides a balanced analysis on the impact it may have on various players. I am taking this one step further to provide my understanding and implication on individual investors.
The entry fee of 2.25% was being charged by mutual funds (and asset management companies) under the pretext of expenses incurred in marketing and selling of the mutual funds. This amount was being paid to agents and distributions in the form of commissions. With abolishing of this fee, where will mutual funds get marketing and selling budgets? Does this mean they will stop marketing their funds?
One thing that is being overlooked in this euphoria is SEBI’s guideline that mutual funds can levy “a maximum of 1% of redemption proceeds”. In essence, what has happened is the diktat reworked the fees from upfront transaction and moved it at the back of the transaction. Now there are two aspects to this guideline:
- One would still see that the real advantage to individual investors is to the tune of 1.25%. But then, add the commission an individual will pay to the agents or distributor. In addition, the SEBI guideline also instructors agents/distributors to disclose commission they receive from funds (i.e. mutual funds can still pay commission to agents/distributors). Will this come from mutual funds own pocket? How can one stop mutual funds from increasing their operating expenses and charge it under some different heading? Time will tell how it evolves.
- The guideline says upto 1% of redemption proceeds can still be levied. Thus, if the redemption has significant profits and capital appreciation, the actual amount going back to the mutual fund is likely to be higher i.e. real return to individual will get reduced. Even at loss of capital, mutual funds can still charge up to 1% of the redemption value.
At least to me, the only silver lining in these guidelines is that individual investors will have higher capital value that is put to real work. The impact of upfront reduction in capital will be somewhat blunted. Also, the mutual funds performing good and providing better long term returns will actually get more money to keep. The actual value will be depend upon funds performance and invested time frame.
Mr. SEBI, Thank you for reworking the fee or commission structure.
To me, the concept of personal finance advising or agents should be purely a fee based structure. Personal finance advisor taking commission to sell products does not go hand in hand. It is contradictory.
Please note: I have not fully looked into the regulatory guideline or rule. My opinion is based on various news articles in media. I would be open to revisiting my viewpoint if anyone gives me any other evidence based data point.
entry fee, mutual fund agents, mutual fund distribution, mutual fund expenses, mutual funds, regulatory rule, SEBI