Cheaper mutual funds, a good thing?

Most equity mutual funds charge retail investors an entry load of 2.25%, on all investments. Investors have to pay the entry load mandatorily, irrespective of an his or her mode of entry (you may opt to invest in a lumpsum or through a Systematic Investment Plan (SIP).

The total amount collected as load for each scheme, as per the stipulations of the Securities and Exchange Board of India (SEBI), has to be maintained in a separate account by asset management companies (AMCs) and can be utilised towards meeting selling and distribution expenses. As per industry practice the load is normally utilised for paying the agent/distributor’s commission.

SEBI has scrapped this entry load for mutual fund investments made directly, ie submitted through the Internet or to the AMC/collection centre directly, and not routed through any distributor or broker.

First of all, it must be said that SEBI has been throughout the years, doing an excellent job of regulating the Indian mutual fund industry and making it adopt the best international practices as far as is possible. The waiver of load is a similar welcome step that will no doubt benefit the small but informed investor.

However, when I try and look beyond the obvious, I find certain creases that should have been ironed out before implementing this move, which essentially facilitates a small minority to access a cheaper product, that a vast majority has little knowledge of. Whilst providing the informed investor with choice is a desirable objective, protection of the interest of the uninformed investor is critical.

First and foremost, it is appropriate that the load waiver is made applicable to mutual funds in isolation. There are other investment products, which for all practical purposes are mutual funds, only not called so. For example, take Unit Linked Insurance Plans (ULIPs) of insurance companies that are governed by the Insurance Regulatory and Development Authority (IRDA).

These are basically mutual funds that charge far higher loads (from 15% to 75%.) Of course, the charges come down over the tenure of the investment, however, the point is that those charges clearly exist. Moreover, of late the way ULIPs are advertised and promoted, it is difficult for an uninformed investor to differentiate and tell apart a mutual fund from an ULIP product.

Then there are structured products issued by portfolio managers, which too, are nothing but mutual funds that offer substantially higher fees to distributors. Now, in such an environment where products with similar functions co-exist, however, with a vastly dissimilar incentive structure, clearly, there would be a wholesale shepherding and forced migration of uninformed investors to such products.

In other words, there is very much a clear and present danger that the mutual fund industry will end up subsidising competing investment products.


This is not to say that the load should not be waived. Definitely it should be.

However, it should not be done selectively but across the board. Admittedly, this is easier said than done as the regulators of both industries (SEBI and IRDA respectively) differ. However, if any practice is deemed desirable, it should be so, notwithstanding the industry concerned and efforts must be first made by the respective regulators to impose best practices in respect of their products uniformly.

Secondly, the three affected parties basically are mutual funds (AMCs), distributors and investors, informed and uninformed. Though the immediate interests of each of these constituents may differ, they do indeed have a common objective - that of growth and development of the mutual fund industry. The more the industry grows, better the technology and skilled manpower that AMCs can afford thereby engendering more competition and better returns to investors both uninformed as well as informed. However, if the pipe at the beginning is made narrower, other (quasi) mutual funds will take over the market to the detriment of the uniformed investor.

It is only in a perfect world that the uninformed investor will pay the load for the advice and service he is getting. More often than not, the uniformed investor is uninformed about the fact that he is uninformed. If a zero load is available he will want to avail of it and eventually it will lead to load shopping with distributors indulging in blatant rebating just to get additional business and the associated trail commission.

That being said, I cannot emphasize enough that it doesn’t mean that a knowledgeable investor is forced to pay someone for services that he doesn’t need. For such persons, dedicated no-load schemes could be offered - in fact it could be made mandatory for mutual funds to operate no load schemes for each category of its products. The only submission is that imputing zero loads across the board in existing schemes will confuse and corrupt the market. A scheme should be either with a load or without.

The bottom-line

As a consumer, I too look forward to cheaper financial products. However, I hope the authorities come to a decision after careful consideration of issues such as those laid out in this column. For, as an informed investor, I don’t want to end up saving two but paying twenty.