How to kill Mutual Funds

How To Kill Mutual Funds
August 23, 2010 06:34 PM
R Balakrishnan on saving and investing prudently
Source: http://www.moneylife.in/article/71/8459.html

It is the distributor who expands the market, as was proved again when a foreign bank raised Rs1,000 crore for its PMS when MFs are losing assets


There is a lot of discussion over the fact that mutual funds are not able to increase their assets under management. The reason for this is simple. They are not paying the salesman enough money. Investor preferences have absolutely NOTHING to do with money not coming into equities. Investors have no clue about where to put their money and need some push. Pushed hard enough, they will put money into fixed deposits of companies with no credit rating or low credit rating, dubious real-estate portfolio management schemes or plantation schemes. They need just one nudge from the distributor and they will do it. The retail and the high net worth investors are the ideal clients for smooth-talking sales guys.

Just last week, one foreign bank raised over Rs1,000 crore (yes, a thousand crore rupees) for a portfolio management scheme (PMS). At the same time, ‘experts’ are saying that mutual fund inflows have dried up due to market valuations getting stretched and for other equally inane reasons. I went a little behind the curtain to see what the distributor got from the foreign bank. He got a 4% upfront commission for selling this PMS which itself had a very simple structure. An upfront annualised management fee of 2%, and exit-load of 2.5% if redeemed within 12 months and a profit share if the returns crossed two digits! There was no link to market performance. If the market returns were 30% and the PMS delivered 20%, the PMS manager still got an incentive. It is typical of most PMS structures. And, of course, the return is measured before tax and not after tax.

Now, let me talk of a second PMS, where the value of a Rs5-lakh investment had gone up by Rs1.45 lakh, but all of it was short-term gains. Removing 30% tax, the gain shrank to under one lakh rupees. The PMS manager also deducted his incentive on the gross gain (around Rs0.29 lakh). The investor was left with around Rs0.70 lakh! The more interesting part was that the money was invested three years ago. If one takes the churn into account, the broking firm has made a handsome return. The investors got totally screwed.

What is the connection between the first and the second scheme? It is the same investor of the second PMS who again put money into the PMS of the foreign bank that I mentioned first.

The investor is a fool and no amount of reading or counselling makes any difference to the guy. All that matters to him is a slick distributor making a sexy PowerPoint presentation and perhaps treating him to a drink or attacking some other weakness of his. In any case, neither the investor nor the distributor understands the product. What the distributor knows is that by selling this, he makes 4%. So, he sells. For the investor, it is ‘long-term’ investing advised by an ‘expert’.

It is the distributor who is the key to the expansion of any market. By taking him on, the regulator has killed the reach of the mutual fund industry. No mutual fund can build a distribution system of its own and survive, given the paltry amount that is available to meet expenses.

To top it, we are seeing a toothless and mindless agency like the Association of Mutual Funds in India (AMFI) trying to slam the distributor with a nine-fold increase in ‘registration’ fee. I do not know why a distributor has to have a registration with AMFI which is only a trade body. Its inability to do anything meaningful has been demonstrated by the fact that even the test it used to hold for distributors, was a sham and it has now been transferred to an agency of the Securities Exchange Board of India. Why should AMFI have anything to do with the distributors? Distributors should ignore AMFI and have their own trade body. If I were a distributor, I would simply not sell a mutual fund product. I can sell PMS or insurance and make my living.