The intent of the regulator on TER reduction was very clear; pass on the benefits of scale to investors by reducing expense ratios. While the intent of the regulator is justified, the regulator’s direction on execution part could have been better.
Faulty execution of this well-intentioned move can further increase mis-selling, reduce the number of new entrants and put a halt to increasing mutual fund penetration.
Let me explain why:
- AMCs may not take a hit of TER cut fully. They may try permutations and combinations to ensure that their profitability remains intact. This naturally means lower margins to the distribution fraternity. Many distributors will now look at alternative products to offset their losses. In my view, the only way to sell alternative products is to raise doubts on mutual funds as an investment vehicle and I do not think this will be good for the industry in the long run. Also, think about clients who will be sold complex products like insurance and PMS.
- One of the innovative ways for AMCs to ensure better profitability and push sales is to offer a ‘dual’ brokerage structure. In this structure, distributors get low brokerage on existing assets and high commission for incremental business. Basically, this practice could encourage distributors to churn.
- Difference in brokerage between a large sized scheme (usually large cap and hybrid schemes) and small sized funds (largely mid and small cap schemes) can be as high as 50-60% - 0.90% trail in large scheme against 1.40% trail in small schemes. Now to put this in context, the distribution fraternity has seen close to 50% reduction in their revenues over the last two and a half years due to the introduction of service tax/now GST, ban on upfront commission and now TER reduction. Naturally, a few distributors may move to small sized funds, increasing the chances of mis-selling.
It is strange that people have not realized the extent of damage that poor execution can cause to the industry in the long term.
I think that there will be massive churn in AUA over the next one year. While this will not go unnoticed by SEBI, distributors may be held responsible for the increase in churn. And the distributors will be on the receiving end once again. I feel we are entering into a vicious cycle of self-destruction!
In my view, if the regulators intend to do the right thing, it is not too late. They should step in and ban the dual brokerage structure offered to distributors by AMCs. Also, if AMCs could absorb a larger portion of the TER reduction, it would reduce the brokerage gap between large and smaller sized funds. This may hurt in the short run but will yield better results over the long term.
The author is the CEO of FinEdge Advisory
The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.
