Big Fish Gain
1. Earlier, if a client invested in an MF through an agent (IFA), the latter would receive a percentage of the entry load (approx. 2.5% of entry load) and an annual commission known as trail
2. The agent, who brought in the client, would continue to get the trail even if the investor changed the agent
3. Under the new Sebi guidelines, the trail will change hands if the agent is changed. Industry experts fear this may lead to large fund houses taking away clients from smaller agents
Mumbai: If the abolition of entry load was not enough to hit smaller mutual fund agents (also called independent financial advisers or IFAs) hard, a Sebi directive of December 30 has thrown open the market for large distributors to cannibalise the existing clients of smaller MF distributors for trail commissions. It has also okayed the use of hard cash in the MF industry – something that Sebi has been trying to replace with compulsory use of cheques in all MF-related payments. Additionally, expense for fund houses could also rise, top industry players said.
The email sent by Sebi to Association of Mutual Funds in India (AMFI) 10 days ago said that all fund houses should follow an AMFI circular of September 2007 that had initially laid down the rule for change of MF agents for an investor and payment of trail commission.
In industry parlance, a ‘trail’ is an annual payment received by an agent for bagging a client for the fund scheme. This payment varies from one fund house to another and ranges between 30 and 50 basis points (100 basis points = 1%) of the market value of the investment.
Till August this year, when an client invested in an MF scheme through an IFA, the latter got a large share of the entry load (about 2-2.25% of the total investment) that the fund house charged the investor. In addition, the agent also got an annual trail commission from the fund house till the time the client stayed invested. The trail was calculated on the current market value of his investment and not on the initial amount invested.
For example, if a client invested Rs 1 lakh in an MF scheme, the fund house paid about Rs 2,000 to the agent as upfront commission. Thereafter, the agent got about 30-50 bps each year on the market value of that Rs 1 lakh investment. Even if the investor changed his agent, the trail was always paid to the original agent and not to the new one, similar to the practice followed in the insurance industry.
In August 2009, Sebi abolished the entry load but allowed the trail payment to IFAs to continue. The ban on the entry load hit the small IFAs hard, especially those whose livelihood depended on selling mutual funds.
The AMFI circular of 2007 had initially allowed payment of trail commission to the new IFA in case of a change of agent. However, due to differences among fund houses, it was put on hold. Sebi’s email last week has now directed all fund houses to pay trail to the new IFA in case of a change of IFA for old investments.
Top officials fear that small IFAs who are still getting trail from investments they had brought into fund houses earlier, might lose out to big and organised MF distributors. And this could also bring in the practice of ‘pass back’ into the industry and also increase costs for fund houses.An email sent to Sebi for its comments on the issue remained unanswered for over a week.
Most fund houses are against this change although there are a few who are supporting the move. “By sheer money power, big agents can snatch away trail income of a large number of smaller IFAs,” said head of sales at a large fund house.
For example, if an investor has an investment of Rs 10 lakh in an MF scheme, the IFA, who had brought this investor into the scheme, gets about Rs 3,000 this year as trail.
Now under changed circumstances, a big distributor might approach the investor and offer him a cut from his Rs 3,000 trail in case he agreed to change his agent. The incentive, or cut from the trail (also called pass back), is in cash and, in most cases, unaccounted for.
“It could also lead to polarisation of large distributors in the industry, which, in turn, could lead to increase in cost of assets,” said head of another local fund house. “In such a situation, large distributors could even force fund houses to shell out a higher trail,” the official said.