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No entry load on mutual funds: Who wins, who loses

By Amit K
July 07, 2009 14:20 IST
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The recent ruling by the Securities and Exchange Board of India, SEBI, on the removal of entry load on mutual fund investments has brought appreciation as well as criticism from different corners. Last year SEBI had done away with entry load in cases where the investors directly invested in mutual funds without going through an agent or a distributor.

With the new ruling in place, investors will be free to negotiate the commission with their distributor and if they are smart negotiators they may even pay nil commission on their investments. Good news for some, not so good news for others. Well let us have a look as to who stands to benefit and who stands to lose out and the implications of SEBI's decision for investors, distributors and mutual fund companies.

Who will benefit?

What a silly question to ask? Of course, you, dear investor!

How? Because now that there will be no entry load on the money that you will invest in any mutual fund scheme all the money that you invest will be used to buy mutual fund units unlike earlier when 2.25 per cent would be lopped off and the rest invested. The table below illustrates this better.


 

 

 


As seen in the illustration above because of no entry load on your investments you will make Rs 9,102 more than what you would have made otherwise. According to the new ruling, investors will decide with the distributor, an upfront commission or fees to be paid for their advice and services.

The benefits for investors are:

  • No entry load
  • Distributors will get a fee for their advice and hence distributors will have to give the right advice rather than promoting schemes, which offer them superior brokerage
  • No more churning of the portfolio of the investors which many distributors used to indulge in especially when a New Fund Offer (NFO) would be announced to earn hefty commissions without any care for your money

Some distributors would make the investors exit their old funds and make them invest in new fund where the commission would be high. It is not that NFOs are not good investments but this practice which some of the distributors used to follow was wrong and unethical.

However, the flip side is now there also will be no cash back to the investor. Earlier, the practice was that the distributor would pay back the investor a small amount out of the commission he earned from mutual fund companies making the investor feel good about it.

The recent SEBI move brings in a greater degree of transparency in investments in mutual funds and investors will be benefited as they would now get real advice in the true sense.

Who loses?

The retail distributors, the fund houses to some extent, and the relationship managers of banks who made a neat commission out of their advice to investors on which funds to buy and sell.

How?
 
They will now have to negotiate with the clients and decide on a fee (smart investors can negotiate this to their own benefit) whereas initially they used to get a fixed brokerage from the fund house.
 
The taxation angle, though, is also not very clear.

Initially service tax was deducted from the brokerage and the balance was paid to the distributor. Now it is still not clear how the service tax will be paid.

Whether the distributor will collect that amount from the investor and then pay the tax or is there any other methodology still stands to be clarified. If distributors have to pay a service tax, then they will have to take a service tax number. This in turn can lead to distributors asking fees in the form of cash in order to avoid the service tax.
 
The retail distributors may reduce or may entirely stop selling mutual funds as it may no longer be lucrative to them. This will hamper the business of fund houses.
SEBI has also passed a ruling for the distributors to disclose their commissions and other benefits. This ruling obviously did not go down well with the industry.

There are no changes in the exit load as of now.

SEBI's ruling will be applicable to:

  • All investments in the mutual fund schemes -- including additional purchases or switch from one scheme to the other -- with effect from August 1, 2009
  • New schemes launched from or after August 1, 2009
  • Systematic investment plan (SIP) registered on or after August 1, 2009

There are still lots of ifs and buts as SEBI is still to issue complete guidelines. But this preliminary guideline too is a revolutionary step in itself as investors will now be paying for the right kind of advice.

The system of pass back wherein distributors used to pass on their incentives to the investors for inducing the investors to invest in a particular fund to meet their personal targets will also be done away with. Now investors can gain access to well-informed and proper advisors, financial planners to get proper advice for their investments in accordance with the fee that they pay.

Amit K is a certified financial planner

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