The reason behind 15 bps expense ratio reduction

In the larger and best interests of the investors, I applaud and fully support the regulator SEBI’s decision and intent for the Gazette Notification No.SEBI/LAD-NRO/GN/2018/14 dated May 30, 2018 on Amendments to SEBI (Mutual Funds) Regulations, 1996, under which the additional expense under Regulation 52 (6A) (c ) is being reduced from 20 bps to 5 bps.

What I understand is that SEBI has been questioning AMCs on sales practices followed at their end on exorbitant payouts to select large distribution partners and also on the practice of offering large non monetary benefits in the shape of foreign trips and shopping vouchers etc., and a major chunk of the cost/expenses for such additional deemed benefits being offered to such large distribution partners were being booked by AMC/s under this additional expense of 20 bps. Hence, the additional expense which was directed to promote mutual fund investments in the larger context was grossly misused to benefit just a select set of large distribution channels.

On ground implementation going against SEBI’s intent

One would have thought that the immediate fallout of this reduction of additional expenses from 20 bps to 5 bps would therefore be curtailing the activities that SEBI was frowning upon – which means drastic curbs on foreign trips, shopping vouchers and such other questionable inducements to procure business from distributors.

To my rude surprise and shock however, I received a mail from a leading fund house stating that they are reducing trail commission payable to me on all assets – old and new, across prominent of their equity schemes and a few debt schemes as well by 15 bps, citing this SEBI decision and citing AMFI’s guidance to re-align commission payouts.

And at the same time, none of my IFA friends who are packing their bags for the next trip being sponsored by some AMC, received any communication stating that the trip had to be cancelled due to the same SEBI decision and AMFI advice.

Ethical IFAs paying the price for others’ excesses

So, IFAs like me who have completely stayed away from all these unethical inducements and have only worked on the basis of trail commission which is a win-win-win for investor, distributor and fund house, will now pay the price for excesses committed by fund houses favouring few large distributors. Then there are thousands of small IFAs who never get invited to any of these trips, but whose trail commission will nevertheless get reduced by 15 bps – even as the big boys continue to be induced by everything that SEBI is frowning upon. Why should we pay the price for someone else’s excesses?

Contract should be binding both ways

There is another aspect that I simply cannot understand. When expense ratio fungibility was given, when this 20 bps additional was given by SEBI, fund houses increased trail commissions on new business. But they kept the trail on old assets at the same level, citing a “contract” between them and us. Now, when this 20 bps is withdrawn, these fund houses are not only reducing trail on new business that was mobilized on higher trail, but also on old assets where we never got a higher trail in the first place. How can this be justified? If a “contract” prevented them from increasing my trail on old assets, how come the “contract” does not protect me from commission reductions?

Sensible way forward to implement the 15 bps reduction

I completely understand that when expense ratio is reduced, both parties – fund houses and distributors – will see some negative impact. But, this needs to be done in a fair and equitable manner rather than one in which smaller IFAs and ethical IFAs pay the price for unethical practices between fund houses and large distributors. I would like to humbly submit to all AMC CEOs the following points which I believe will enable a fair implementation of the expense ratio reduction:

• Put a complete stop on any foreign trips and / or any other inducements to distribution with immediate effect. Strictly adhere to moral and ethical code of conduct on sales practices.
• Discipline and cap the exorbitant payouts and benefits given to AMC Sales staff and the Fund Managers
• Reduce trail commission on prospective business.
• Where existing trail commission is above 70% of distributable TER, reduce such trail to reasonable levels. For example, where a fund house is offering a trail of 1.5% to a distributor on a fund whose distributable TER is 1.9%, reduce the trail to a level that brings a more reasonable balance between what the distributor makes and what the fund house makes.
• Where existing trail commission is anyway less than 60% of distributable TER, leave it untouched.

If these 5 steps are implemented, I am confident that fund houses will be able to effect savings of 15 bps or more to offset the reduction in expense ratio. At the same time, they would have taken action to curb excesses wherever they are – either excesses in inducements or excesses in commissions or for that matter excesses in managerial compensation. The intention of the regulator is to curb excesses – not to punish ethical IFAs. Please consider the spirit of what the regulator is trying to do, and do what is right for your investors, your ethical distributors and your business.

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