Mutual fund distributors need incentives, and investors, awareness and education

Sebi has tweaked the rules to popularise mutual funds (MFs) and also raise retail participation in initial public offerings (IPOs). These reform measures are welcome. Restoring incentives will enable distributors to sell more in the hinterland.

The compensation is in the form of allowing a higher proportion of the savers’ money entrusted to the mutual fund to be set aside for the asset management company’s expenses, including for distribution. Fund houses can now charge an additional 30 basis points, provided 30% of their annual inflows come from places other than the top 15 cities.

However, the charge would be on the entire fund, making investors residing in top cities pay for new investors in the hinterland. Exit loads have to be reinvested in schemes. Rightly, this will enhance returns for those who stay invested. The regulator has also done well to allow fungibility in the expense ratio, giving MFs the leeway to pay more commission to distributors.

This is a recognition that distributors will not sell MFs without a fair compensation. Now, the government also plans to bring MFs under the Rajiv Gandhi Equity Scheme that offers tax breaks to small investors in stocks. Small savers will benefit as they are ill-equipped to invest directly in stocks.

It is also less risky as MF holdings are diversified and stockselection is done by professionals. However, aggressive customer education is a must to prevent brokers from advising clients to churn their portfolios just to corner distribution incentives.

The practice of getting investors to take their money out of well-performing existing schemes to subscribe to new fund offers was rampant till August 2009, forcing Sebi to ban entry loads.

But that crippled the industry. Therefore, a self-regulatory mechanism to oversee MFs makes sense to prevent mis-selling. So does making fund houses earmark a slice of their asset management fees for investor education.

Other measures such as encouraging retail investors to use Asba, introduction of e-IPO and assuring minimum allotment will help expand the retail base. The government should also restore the confidence of FIIs with a credible plan on fiscal consolidation.