Since the advent of mutual funds in the 50s and 60s and then index funds in 70s, ordinary people have benefitted from global stock market moves. Every second American is a mutual fund unitholder. It is true for Europe, China and East Asia.
Mutual funds are the way towards financial security for most people in the world.
In India, the mutual fund industry was synonymous with Unit Trust of India since 1961. In the 1990s, the Securities and Exchange Board of India became the stock market regulator. Since then, SEBI’s mutual fund regulations have governed mutual funds in India.
Over the years, SEBI encouraged the creation of self-regulatory organisations to standardise business practices. The Association of Mutual Funds in India or Amfi is such an organisation for the mutual fund industry.
A critical bone of contention between SEBI and the mutual fund industry is the high expense ratio. Asset management companies charge the investor an average 2.5 per cent of assets under management for a diversified equity fund. It is lower for debt-related assets. Mutual funds use the money for distribution of mutual funds across India. So much so that distributors bring more than 80 per cent of the total mutual fund assets currently under management.
A standard practice used to be to pay an upfront commission to sell any mutual fund scheme. This compensation allowed distributors to get new investors rapidly. Mutual Fund assets have doubled in three years since 2016 and now manage close to Rs 25,00,000 crore.
Lately, though, there is a fall in new investors signing up for mutual funds.
Net inflows to equity mutual funds have hit a new low. According to one analysis, mutual fund net inflows touched a 31-month low. A net inflow is an amount added to mutual fund assets after taking into account redemption or selling of units by unitholders. For the month of January 2019, it was half of the monthly average of Rs 10,000 crore received as net inflow in 2018-19.
This is a sharp fall and could be due to sluggish performance of equity markets over the past year. Another reason is the change of rules over the commission.
Asset management companies are no longer paying an upfront commission. SEBI is pushing them to pay a trail commission. This commission is the money paid periodically to distributors based on the investment made. So, instead of receiving an upfront commission, distributors are now getting paid monthly or annually.
In the meantime, insurance companies have witnessed a steady growth of over 17 per cent in monthly net
inflows in January 2019. They continue to pay upfront commissions. There is a good chance that financial advisors and distributors of mutual funds could favour unit-linked insurance policies due to that. Financial advisors distribute a diverse set of financial services products. A financial advisor or distributor registered to sell mutual funds can also sell insurance or fixed income products of banks. While the Insurance Regulatory and Development Authority of India or IRDAI regulates insurance companies, the Reserve Bank of India regulates banks.
Compensating distributors and financial advisors differently for different products could result in a particular sales behaviour pattern. Financial advisors may promote insurance products over mutual funds or vice versa based on the compensation they get.
What you should do
As an investor, you must understand that insurance is not an investment. You buy insurance for protection. It is not a rival product to a mutual fund. Investors should not discontinue their existing mutual fund systematic investment plans for unit-linked plans promoted by insurance companies or fixed deposits from banks.
There are already signs of a reaction to the new fee structure. The number of active systematic investment plans fell to 1.87 lakh in December 2018, according to the data compiled by Amfi, the mutual fund body. It is a third of the average it received every month in 2018-19.
There are reasons for a drop in active SIPs. The discontinuation of Aadhaar as a verification tool means that mutual funds have to resort to the ‘know your customer’ process that existed before the introduction of Aadhaar. The other important aspect is the underperformance of equity markets. The value of your mutual fund investment has barely moved in the past year. However, if equity markets are not performing or underperforming, it is an opportunity for investors to buy more and benefit from the rupee-cost averaging. Snapping systematic investment is not the solution.