The brouhaha over mutual fund costs
Low incentives and high compliance costs will tilt the industry in favour of the well-heeled, unintentionally
In the past two months, the regulator has decided to slash around 30-40 basis points (bps) of mutual funds’ total expense ratios (TERs); maybe guided by concern about declining alphas and realising scale economies on the back of rising profits of asset management companies (AMCs). Considering that deductions are coming out of TER components with the purpose of supporting distribution reach, maybe their utility is served and they deserve to be corrected.
Alpha-related discussions based on performance of last 1 year are avoidable since calendar year 2017 was an outlier. You don’t expect stock pickers to beat the index when everything is flying. In 2017, Nifty and Midcap 100 ran up by 28.65% and 47.26%, respectively, while BSE Small Cap did some number over 50-60%.
Regulations' focus is on protecting “the small guy”, but market forces make it difficult precisely for this guy. A Rs3,000 SIP collecting Rs36,000 in a year costs about Rs15 to register with the bank, Rs2-5 per debit, Rs5-7 for Aadhaar linking, Rs2-5 for dividend credits and service cost, built into 5-10 bps (depending on the size) of the assets under management (AUM) as registrar and transfer agent (RTA) cost. Add to this, per transaction cost paid to NSE, BSE, NSDL, CDSL, MF Utility, and others. Compliance and transaction costs are rising by the day preventing any scale of economy. Even at a conservative cost of Rs75 per year of running this SIP, it’s 0.21% per year. That’s over and above the cost of RTA, custody, trustee, audit, banking charges, and others.
It costs the distributor more in conveyance than the commission that SIPs can generate. A few large clients end up paying for all others. If she spends Rs300 per year as conveyance, ignoring other costs, that’s 0.83%. Whatever the TER, this is per folio cost of servicing 90% of the industry’s base. Who is paying for all this? Anyone who invests more than Rs36,000 or a similar threshold.
How are asset management companies (AMCs) making money then? Well, if they are, it’s not because of SIPs or retail inflows. AMCs are either not making money or are making some because of appreciation of assets aged over a year or two. But appreciation is never a one-way street. TERs are not cut on incremental assets; they are cut on the entire book. When we reduce TERs, we nudge everyone higher on the targeted segment of customers.
The other regulation that may go against “the small guy” is segregation between distribution and advice. An intermediary can either be a commission-based seller who can’t advise or an adviser who can’t earn commissions, only fees. Suppose a distributor of SIPs, not focused on “unit economics” but building a client base where “eventually” is the key word, decides to become a fee-only adviser. This SIP would pay about Rs360-540 as commission per year. Compared to that how much fee this SIP investor would pay the distributor who decided to become an adviser? Retail investors will be with commission-earning distributors and if they demand advice, they will have to pay more. On the other hand, the entire cost reduction, if any, of moving from distribution-based engagement to advisory fee will go to affluent investors. In any business, it’s the big guy who pays for the small guy. Effectively cross-subsidization across investor segments within any distributors’ business will tend to be zero and retail investors will face a service gap.
Retail advisory sounds like and is an oxymoron unless mass-customised (another oxymoron), but the day the market takes a U-turn, the efficacy of remote channels in curbing emotional reactions will be reduced to fighting a battle against the fastest finger first syndrome—a click on the “redeem” button; instant satiation of the desire to take “evasive action against further erosion”.
Funds don’t always give positive returns, so let’s not judge enthusiasm based on investors’ actions when returns over every time horizon show double-digit growth. Investors who are going direct without advice are likely at highest to lowest returns, but NAVs, shares and bond prices change and the next one year may be different.
No one wakes each morning thinking, “Today is the day I am going to buy a mutual fund and secure my goals.” Financial planning, asset allocation, insurance, gymnasiums and preventive health check-ups are push products or New Year resolutions. It needs real people to push right things; that’s enough value addition to justify meagre fees and commissions in the face of rising transaction and compliance costs. Ensuring people get introduced to capital markets and move away from bank deposits and small savings schemes is value-add enough.
People respond to incentives—right incentives with regulated role play is the way to go. Low incentives and high compliance costs will tilt the industry in favour of the well-heeled, unintentionally.
Aashish P. Somaiyaa is managing director and chief executive officer, Motilal Oswal Asset Management Co. Ltd