Sebi's cuts for MFs to be costly affair for new distributors, smaller AMCs

The Securities and Exchange Board of India's (Sebi's) recent move to cut expense ratios and ban upfront commissions could come as a heavy blow for new distributors and smaller fund houses -- the categories the regulator would like to see grow. Experts warn that individual investors could also miss out on access to advice if advisors don't find mutual fund distribution to be a viable business.    

According to the chief executive officer of a mid-sized fund house, while larger fund houses should be better-placed to absorb the overall cut in total expense ratio (TER), the impact could be larger for a smaller fund-house with a limited profit pool.   

The market regulator on Tuesday capped the maximum limit on expense ratio from 2.5 per cent to 2.25 per cent. While this limit was for open-ended equity-oriented schemes, other categories of schemes also saw cuts. The regulator also stated that the industry must adopt the full trail model of commission, without any upfront commission or upfronting of any trail commission. 

In a research note, CLSA analysts said that cut in TERs can have a 25 per cent impact on the mutual fund industry's earnings. The TER change “will have direct negative impact on overall revenue yields for most AMCs in the industry", according to analysts at Emkay Global Financial Services.

Markets are already factoring in some of these earning cuts. The share price of the two large listed asset managers -- HDFC AMC and Reliance Nippon Life AMC -- took a heavy beating on Wednesday. The share price of HDFC AMC touched an all-time low of Rs 1,397 per share since getting listed in early August. The share price of Reliance Nippon Life AMC also dropped to an all-time low of Rs 186.2.  

Distributors fear that once again they will have to do the heavy lifting as the industry tries to absorb these cuts. According to analyst estimates, when Sebi had cut additional expenses by 15 basis points (bps) in May, fund houses passed on between 70 per cent and 100 per cent of the impact to distributors. Certain fund houses say distributors will have to again bear at least 70-75 per cent of these cuts.  

"The blanket ban on upfront commissions makes it a double-whammy for distributors, especially the smaller ones who have recently entered the industry," said Dhruv Mehta, current chairman of Foundation of Independent Financial Advisors (Fifa), a body that represents financial advisors and distributors.

Industry sources say that it would take a much longer time for a distributor to build a large enough asset base to break-even just from trail commissions.   

"All of a sudden, the new entrants will have to take a re-look at their fundamental business assumptions if they want to stay in this business. It typically takes seven years to break-even in the distribution business from the time you enter. However, now it may take as much as ten years. It wouldn't be surprising if several distributors decide to exit," Mehta added.

"Given the smaller ticket-size of systematic investment plans (SIPs), even if some kind of upfronting is allowed, it would do little to recoup the client acquisition costs that are incurred on SIPs," said another distributor. Others say the move unfairly shows distributors in a negative light as those who just churn schemes for upfront commissions. Putting caps and closely monitoring these caps would have been a more pragmatic move, they say.

Even asset management companies say that these moves can make distributing mutual funds a less attractive business proposition and could drive distributors to other products. "The ban on upfront commissions could further tilt the balance in favour of unit-linked insurance plans (ULIPs). The insurance industry has controls, but not as stringent (as these) ones on commissions. Already, ULIPs have been given a tax arbitrage as they remain exempt from long-term capital gains tax," said Aashish Somaiyaa, chief executive officer of Motilal Oswal AMC.

Lack of independent financial advisors (IFAs) is already seen as a challenge to growth of MF industry. As of September 2017, the IFA tally in India stood at 77,525, translating into just one advisor servicing every 1,000 clients.