Entry load on Mutual funds to be abolished
Investments in mutual funds may not suffer deduction of ‘entry load’ for too long. In a move that will empower investors to determine the price they will pay for service received from a distributor, thereby reducing their cost of investing in mutual funds, the Securities and Exchange Board of India (SEBI) has asked fund houses to do away with entry load on all their schemes.
Entry load is the typical 2.25 per cent (maximum of 2.5 per cent) charge levied at the time of investing in mutual funds, mostly equity funds. While this may not seem like a conspicuous charge on paper, the levy goes to reduce the final number of units allotted to you. Such levy is almost entirely utilised by the fund house for paying the commission to the distributors for marketing their fund. In other words, a small portion of the money earmarked for investment — in the name of entry load — is paid to the distributor.
SEBI’s new proposals allow investors to directly make payments to the distributors for their services, instead of mutual fund houses deducting the same from the investment amount.
To provide an example: Had you invested Rs 10,000 in a fund which had an entry load of about 2.25 per cent and an NAV of, say, Rs 10 per unit, then, only 977.9 (10000/10.225) units would have been allotted to you, as the entry load of 2.25 per cent would have increased your cost per unit to Rs.10.225.
Under the new proposal, investors would be able to receive units for the entire amount of Rs 10,000 invested; they may have to draw a separate cheque in favour of the distributor towards a mutually agreed service fee.
This essentially means that an investor may have a choice of paying nil/small commission to an ‘no frills’ agent or go for a distributor who charges slightly higher fee, perhaps for other superior advisory service offered in addition. Viewed differently, investor will now be ‘aware’ of the commission they pay; there would be no hidden marketing charges.
Reason behind the move
While this proposal is clearly aimed at allowing the investor to decide what to pay for the service received by him/her, the move may also eliminate gratuitous churning of the portfolio by investors. In an entry load regime, distributors typically benefit more every time a fresh investment is made. Hence, it was not uncommon for distributors to recommend a switch between funds, causing churning.
Now, under the new proposal, the commission to be received by a distributor may be uncertain; the only other key source of the agent’s income would be the ‘trail commission’ received from the fund house for retaining a customer’s investments. So the motive for recommending fresh transactions may be less.
Role of invester
Once this proposal comes into force, investors may be prompted to immediately scout for a no/low commission distributor. Beware! For one, you may be sold a fund with a poor track record or one on which the agent receives a higher ‘trail’ commission. That may not be the best fund for your portfolio. Please bear in mind that a consistent long term track record and a risk profile that suits your appetite should be the key factors that determine your investment choice.
As we have always maintained, in the Indian market context, an entry load of 2.5 per cent or a commission paid to the distributor is a small sum, compared to the 12-15 per cent annualised return that a good equity fund can easily yield.
Two, if commissions on MFs go down, products such as ULIPs may look attractive from a distributor’s point of view given their lucrative commission. Ensure that you are not sold an ULIP when you do not want one. ULIPs are long term insurance-cum-investment products. They generally build in expenses upwards of 10 per cent, in the initial years. This sum would be deducted from your investment amount.
So as an investor, what should be your response to this change?
As always, ensure that you choose a fund based on its track record. Expenses or commissions come next.
Do not be diverted into buying ‘other’ products if your objective is to buy a mutual fund
If you are a less-informed investor and need advice, do not hesitate to pay a decent sum to a good financial advisor/distributor. There are no free lunches.
If you are a well-informed investor, making your own investment decisions, you can apply for funds directly through their portals or approach any of the local offices of the fund house you want to invest in. This way there would be no commission. If you wish to make such an investment through your online broking account, you may do so; this would however entail paying a fee.
As a distributor has to now reveal the commission that he receives from the fund house for the product, ask him for the same. That way, you will know whether you are paying too high a commission or otherwise.
There has been no indication so far as to the implementation date of this proposal. There are also other grey areas in implementation of the same, especially on the distribution side, which too may have to be addressed.