Adopted Father

The mutual fund industry in India reminds us of a strict disciplinarian father and his brood in a very Victorian family. Given that the regulator came into being long after the mutual fund industry had started, it is a case more of an adopted father who came onto the scene a bit late in life. He was assigned the onerous task of disciplining a bunch of kids, but was never really geared up to the challenge.

The situation also reminds me of Akash, my neighbor who in the past five years that I have known him has never ever told his son what to do.

Every time his son Sunnee approached him with a problem, he only offered him his situation analysis, various options available and facilitated decision making process for the child. He had started this practice the day Sunnee celebrated his tenth birthday. On the other side, in case Akash had to communicate something to Sunnee, it was always informative, rarely prescriptive.

Yes there were certain rules of engagement, which had been formulated and institutionalized so as to prevent chaos from seeping in, like Sunnee has to be back indoors by sunset. Each such rule had been established after explaining the justification to the young boy and also providing a sunset clause for the rule, which in the case of the sunset rule had been defined as his fifteenth birthday, when it would be extended to nine pm. BTW fifteenth birthday would be when Sunnee would be expected to help with the dishes on alternate days.

In many ways the mutual fund industry in India resembles a large Victorian family, and the father is an absolute opposite of Akash, who has been deciding everything for the brood, that the kids have now grown up into an adult but yet cannot decide on his own and has to depend on the father. Can the father himself move away from a prescriptive father into a “vague” “ambiguous” father who can lay down the principles of engagement and expect the son to interpret them, and adhere to them in a judicious manner?

Let us look at the two issues that has plagued the Indian mutual fund industry for ages; the TER and the Distribution fees, both are interlinked, ever since the industry was born, right from the days when the funds were allowed an initial expense of 6% for covering the IPO expenses. Yes that is right, an investor subscribing in the IPO would suddenly find the opening NAV to be Rs 9.40.

The aspect of distributor fees/commissions is even more complicated. The number of twists and turns seen on this story can put Ekta Kapoor’s team of writers to shame, for the Regulator seems to be spectacularly clueless on the right model.

One fine day it finds the distributors to be the bad boys, only to realize by sunset, the critical role of the distributors in the process. Then by morning, it comes up with the grand idea, let the investors have the option. It mandates all the Fund Houses to come up with an additional “Direct” Plan, so that investors who still want to get fleeced can invest in the Regular Plan.

As an aside, imagine the conversation that may happen between an investor and a distributor in a town like Raipur, if at all there are investors who can ask questions.

“What is the difference between Direct and Regular?”

“Sirjee Direct is a new plan, but we will stick to the Regular.”

By connotation itself, “Regular” refers something to which an ordinary investor should stick to.

Yet the assets under Direct plans have now swelled to one third of the total, atleast that should be a wake up call to the Adopted Father, who should now start to work on a principle based approach, instead of prescribing rules to grown up adults.

Firstly instead of mandating on what and how much Fund Houses can pay distributors, it should simply stop Fund Houses paying to distributors from the TER. That itself would bring down the TER by almost 100 bps. Beyond the TER the Regulator cannot stop if distributors are paid for “consultancy services”, but that is a different story, and neither investors nor the regulator should bother if the AMC is paying out of its balance sheet.

Instead of mandating fund houses to disclose commissions paid to distributors on the account statement, which would further clutter the statement, the statement should inform the investors that the Fund House has NOT paid anything to the distributors and the investors are free to directly pay whatever they think is suitable for the services rendered by the distributor.

Investors, whether in Mumbai or Mathura, are smart enough to realize that there is no such thing as free lunch. If the distributor is doing some work for the investor, then there has to be something in it for him. It is been a few decades and high time the distributors got used to justifying a fee for their services to the investor who signs the investment cheque.

The so called “Regular” plan should be merged into the Direct Plans thereby streamlining the products available in the market. Today, even after an investor decides to invest in an AMCs’ XYZ Fund, she still has to work through a maze of Plans, Options, sub-Options before she can complete the CAF. Fund Houses have become NAV production facilities.

The Regulator can then move onto removing the price controls imposed on the AMC on the way they can price their services. Instead of working on mandating a ceiling on the TER, it should specify the operational TER for covering the administrative expenses, let us say at about 25 bps, and on top let the AMC have the freedom to charge IM fees as it may deem fit, making the Board of Trustees to sit on judgement on the justification provided by the AMC Board. Eventually the Regulator can totally move out of price control mechanism.

The Regulator should restrain itself to questioning the Trustees if it finds an AMC charging fees, out of sync with the performance of the Fund. Let us say if some dynamic AMC Board charges 100 bps on a Fund which has given negative returns vis a vis the benchmark, it is the Board of Trustee that should be accountable to provide a justification to the Regulator.

Before expecting the children to behave in a responsible manner, the adopted father would have to get into the mode of an enlightened parent.

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