Question: What happens when the teacher punishes the whole class because a few students played mischief?
Answer: Even the honest students suffer.
Question: What does that say about the teacher?
Answer: Following comments can be attributed to the teacher in question :-
1. She is lazy in finding out the culprit.
2. She does not care if the honest students suffer.
3. A blanket punishment will at least ensure her peace of mind and that is all she desires.
Something like this has happened recently when the regulatory authority of mutual funds SEBI has abolished the entry load on equity mutual funds.
To know more about it, the blogger in me (bold font) has interviewed the RM in me. The entire text of the interview is presented below.
What is an entry load?
If an ordinary investor chooses to invest in an equity mutual fund with the help of a distributor, a certain fee amounting to 2.25% is charged to the investor by the company that manages the fund (AMC). This 2.25% is then fully or partially transferred to the distributor as commission.
Why should the investor be willing to forego the 2.25%?
He gets professional advise on his hard-earned money. Investing in equity can be risky in volatile markets. Nothing wrong in spending more to get safety and probably better returns.
Why should the AMC be willing to pay the distributor 2.25%?
For convincing the investor to invest in its mutual fund.
What was the one striking feature of the 2.25% load?
It was uniform throughout AMCs. No AMC can charge a higher load to pass back a higher commission to the distributor which could unnecessarily incentivise the distributor to sell more of the AMC's funds.
What is a KYC?
KYC (Know Your Customer) is a method by which the distributor performs a thorough check on its customer's risk taking appetite and makes a note of his financial goals. These KYC's are then audited to ensire misselling has not happened to the customer.
Which distributors followed this system rigorously? Did they also conduct auditable KYCs on their customers?
Largely banks and reputed Brokerage houses.
Who found loopholes in the system? What wrong did they commit?
Largely small-time sub-brokers. Sleazeballs who live off churning the client's stock as well as mutual fund portfolio to earn more brokerage. They passed a large part of the commission they get from the AMC back to the investor. Of course, they do it in cash. For example, if an investor invests Rs. 10,00,000 in a mutual fund, he will be charged an entry load of 2.25%. Let us assume that the AMC retains .25% of it and passes the 2% back to the distributor. Thus the distributor earns Rs. 20,000. Let us take a conservative estimate and assume that the sleazeball pays Rs. 10,000 out of that to the customer in cash.
Do such "sleazeballs" as you call them do a KYC?
Not to the best of my knowledge. Even if they do, it is quite cursory.
What is churning the portfolio?
It is basically frequently buying and selling securities (stocks and funds) on the client's behalf thereby earning frequent brokerage.
Why is it so wrong that you have to write a lengthy acerbic blog about it?
For the following reasons:
1. Miserly investors for whom even that 1% passback matters will be drawn towards the sleazeballs. I've interacted with many of them and it is hard to convince them to come out of the penny-pinching habit and take a more professional advice. This is to their own detriment as such sleazeballs often make them churn their portfolio and earn brokerage while keeping them happy with passbacks.
2. Law-abiding, compliance-dependent distributors lose out on such business as they are unable to give passback.
Conclusion: Both the investor as well as the compliant distributor suffers.
Who is SEBI?
Securities Exchange Board of India. It is a regulator for mutual funds and other securities. It claims to always be in the interest of the investor.
What has SEBI done now?
It has abolished the entry load system. The distributors will no longer get commission. They are now supposed to charge an investment advisory fee from their customers.
Why have they done that?
To stop the sleazeballs from passing back commission to their customers. No commission = no passback.
What about the honest distributors?
That is primarily why I am so agitated. They did no wrong. Why should they not get a commission?
What about the investors?
Let me tell you frankly, mutual fund is a product that is not 'bought by people', it is 'sold to people'. If the distributors will lose interest in selling them, very few people will proactively buy them. Retail participation will drastically reduce. That is neither good for the mutual fund industry nor for the distributors and nor for SEBI. Apart from regulatory responsibilities, SEBI also has to work on making the mutual fund industry a vibrant one by encouraging retail participation.
What else could SEBI have done?
How about taking the pains to run an investigation by auditing accounts of a select few sub-brokers, gathering intelligence and creating an example by conducting legal proceedings against at least one sleazeball if he gets caught taking passbacks?
What are the far-reaching implications?
The Insurance Industry will get a major boost. Their fees as well as commissions are not uniform and not strictly regulated. Distributors can get upto 40% commission or more by selling a Unit Linked Insurance Plan (ULIP). Insurance policies generate a substantially higher revenue for a distributor than any mutual fund investment. In fact, even before the 2.25% load on mutual funds was abolished, distributors preferred to sell ULIPs as 40% is much higher than 2%. A lot of misselling happened because insurance policies are hardly transparent. Now even with the 2.25% gone, the hardeselling and misselling of Insurance policies will increase further.
So the retail investor will still suffer?
Absolutely. That is why I consider SEBI's move stupid. They made this regulation for the benefit of the investor and my educated guess is that he will suffer more. In any case, there is a separate regulator for insurance - IRDA where SEBI has no say.
Thanks for your time.
Thanks for having me here.
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