Consumers pay only for "pull" services
There seems to be a keen regulatory desire to push commission income based distributors towards a fee based advisory model. On one hand, the notion of empowering the investor to decide what he/she wants to pay to his/her advisor is indeed laudable. There cannot be a disconnect on this principle. The disconnect is however on the timing aspect. It is common sense that a person pays a fee only when there is a strong "pull". When you have a health problem, you go to a doctor and pay his fee - there is a clear pull factor in terms of the person's need and desire to get cured. You pay a lawyer when you have a legal issue that needs to be resolved. When it comes to any capital market product in India, it is still very much a "push" product and not a "pull" product, as the average retail Indian is as yet a good saver but not an investor. The Government pulled out commissions on small savings products after decades of push for these guaranteed return products succeeded in creating a pull. But, to try and move capital market products from "push" mode (ie distribution commission based sales) to "pull" mode (advisory fee based models) is at least 10 years ahead of its time. On the one hand, the Government is trying its best to convince Indians to embrace capital market products for retirement savings (thereby implying clearly that penetration is way too low) and on the other hand, the market regulator believes the time is right to shift from push to pull mode for mutual funds. The irony is that it is the same regulator who also says that penetration is indeed way too low. Pull happens when penetration is high - till then, it is a push product. And you can't push a product when you demand a fee from the buyer. Its really as simple as that. That's one side of the story.
Need to understand what's worrying the regulator
The other side of the story is to consider why the regulator is making frequent changes in mutual fund regulations, which we see as destabilizing our business models. I have written on WF earlier about where we are going wrong in our collective mission to create happy investors (Are we creating informed investors or confused investors?). If we are not able to transmit product performance into investor portfolios, we have to introspect on where we are going wrong, and make the necessary corrections. If a product that has a 15% + CAGR tax free return over last 20 years has still failed to achieve the penetration it deserves, there is much for us to introspect. The regulator seems to have lost trust in manufacturers and distributors and seems to believe that both are somehow putting their own interests ahead of the investors' interests.
Need to narrow our differences with the regulator, not widen it
The way forward for us is not to get hyper about what we perceive as ad hoc decisions of the regulator. The way forward can come only when all stakeholders first agree that our collective objective is to create happy investors. Any proposal we make must first take into account the welfare of our investors and only then our welfare. We want a fair remuneration and we want respect - but above all, we want to create happy investors. The need today is to open a dialogue with the regulator in the spirit of conciliation and understanding and not confrontation. We need to work to narrow the differences between the regulator and the business, not widen them.
Proposal to tackle the root of the problem
I have a proposal which I believe addresses the core issue that's behind commission disclosures and the keenness to promote direct - and which will be in the best interests of investors. I welcome direct plans - they are a good alternative for investors. Distributors are now required to compete against manufacturers, and justify the additional cost through superior value addition. No problems with this. If we are earning a remuneration, we should be able to justify it.
The issue is how this remuneration is determined. Today, each manufacturer determines how much they will pay to each distributor. Competitive pulls and pressures that arise from this situation can influence sales - which is not in the investor's best interests. Such tendencies then start worrying the regulator who comes up with more and more disclosure norms, as a counter-balance to these "market forces".
Apart from this issue, there is a fundamental flaw in this model. We are competing with manufacturers, but it is manufacturers who determine our remuneration. How can our competitor determine our earnings? We have a two TER system in place - regular plans and direct plans. Let the regulator determine a uniform TER for manufacturers (direct TER) and a uniform TER for distributor plans (regular plans). The uniform difference between these two TERs will be the uniform distributor remuneration - across all schemes in the industry for an asset class.
Distributors will earn this as their gross revenue, from which they will defray all their expenses to serve customers. Some may choose to operate a "full service" model where they add value across advice and service, while others may choose to operate a discount model where they pass on some of their earnings to their clients, exactly the way it happens in every other business. Let distributors chose a model that allows them to compete in the manner they think best serves their clients.
There should be full fungibility in both TERs - direct and regular. Both sets of competitors - manufacturers and distributors must have full flexibility to spend money from their TERs for business promotion and client servicing, including providing incentives to their clients.
This is the best way to create happy investors
By taking away the power from manufacturers to determine distributor income, you are tackling the root of mis-selling, which is commission arbitrage. Funds will be recommended solely on the basis of what is right for the investor - as there is no other motivation that comes in the way. This is very much in the interests of investors. And by giving full flexibility and fungibility on how to use the two TERs to both sets of competitors, you are allowing the market to create a wide range of customer propositions. More choice is always better for investors.
Mutual funds being open ended and capital market related, the job never ends with a sale (unlike a guaranteed return product). A sale is just the commencement of a journey and not the end. Distributors are supposed to guide investors through the ups and downs of this journey and help them reach their destinations safe and sound. They deserve a remuneration throughout this journey, not only at the commencement of the journey. Trail commissions enable this. The proposed system is also similar to trail as distribution income will accrue annually from the TER.
Incentive for market development
One aspect of market development that does not find attention in this model is bringing in new investors into the industry. There is considerable upfront effort for this, which must be compensated by an upfront revenue to make the effort viable. The best way to do this is to provide an incentive to any participants - manufacturer or distributor - who brings in a new investor. This incentive can be paid out of the investor education fund that AMFI controls.
If we go ahead with this proposal, the entire industry's attention will get focused only on one aspect - serving existing clients and acquiring new clients. This is the best way for us to create happy investors - which is why we are ultimately in this business.
I wish to make it clear that aforesaid statement is my personal thought process and views without any intention of blaming any one or claiming anything.
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