Distributors' Role in Fund Gathering: Insights from ETG Mutual Funds Round Table

A large cap, diversified equity fund; a mid-cap and emerging company more risky equity fund; and an Index fund for those investors who wish to invest "in the market".

On the debt side, you would need 2 funds: a liquid fund for short-term money which competes with your idle money in your bank account; and a long term debt fund.

And maybe one fund for gold - for those who seek comfort in the charms of the Old World and wish to have some "real currency".

So, based on the above, most mutual fund houses – even with some variations due to the income tax rules - could have maybe 8 to 10 products on offer. Instead, many mutual fund houses have over a hundred products. Most have over 50.

The middle man loves complexity

In India we save about Rs. 15,00,000 crore every year. Even if 20% of this annual savings pool (Rs. 3,00,000 crore) is looking to find a place to invest, we all get the whiff of money to be made. The "manufacturers" of products (like Quantum Mutual Fund) will tell you why investing in a mutual fund is the best thing that can happen to your retirement plan since sliced bread was invented.

We want to manage your money because we earn a SEBI-regulated management fee on it.

Between you and me is the "distributor". And the more funds we offer - the more the distributors are able to sell us: "Dekho ji, inke pass 40 funds hai, lekin yeh 10 fund app ke liye best hai". And the distributor will say this about 3 fund houses. At least.

What does the poor doctor, engineer, lawyer, manager, nurse, and scientist know about the underlying truth – and naked simpleness of the financial services industry? Having studied for years and passed multiple exams to test their skill sets, the doctors think there is something so difficult, something so scientifically complex about our industry that the knowledgeable distributor must be right in recommending 10 funds for his children’s education portfolio.

For every Rs 100 you invest, anywhere between Rs 4 and Rs 6 may never make it to the stock market to buy shares for your benefit. It could find its way into the hands of the distribution channel. That, by itself, is not a crime. The crime is that the advice may not based on what is good for you the investor – but what is good for the distributor’s commission income. The mutual fund house, meanwhile, is also happy. They used the money you gave them to pay the distributor money to get you into their fund as against a fund like Quantum Mutual Fund which does not pay commissions to distributors. Even though Quantum Mutual Fund may have a track record and products that may suits your needs better and, hence, deserves your money.

Yes, there are many honest distributors - and we salute them for giving their clients honest advice. And there are many honest mutual fund houses. But Quantum Mutual Fund has never paid any distributor any commission for raising money. We have nothing against distributors, we have a problem with how they earn their fees in the existing system.

SEBI steps in

Recognising the opaque systems at work in the industry, SEBI banned the system of "rebates". Prior to May, 2002 a distributor would go to a gullible investor and tell him that if he invested Rs 100 in a mutual fund, the distributor would give him back Rs 2.

This was mis-selling at its best, and exploiting the innocence of the investor.

The rebate was the investors own money coming back to him. If he wanted Rs 2 back, he should have been willing to invest only Rs 98 (Rs 100 - Rs 2).

The rebate was actually a portion of the money being paid by the mutual fund to the distributor. So, if the mutual fund paid the distributor Rs 6 to collect the Rs 100 from you, the wily distributor gave you your back-present of Rs 2 and kept Rs 4. Needless to say, he forgot to tell you that small detail.

Thus, cars and holidays to Singapore and Bangkok became the norm to get the distribution channel to drum up money for a New Fund Offering. Banks - and their private client divisions are now the largest sellers of mutual fund products. Selling funds and earning a fee is not bad or illegal - selling funds that pay the highest commission but don’t fit the needs of the investor is immoral and unethical.

SEBI reportedly has stated that it makes more sense to let the investor decide how much the advice he is getting is worth.

The investor can:

either sign a separate cheque to the distributor based on what he values the advice to be; or

in the application form itself, the investor should fill in the amount that the distributor deserves for his advice - from the Rs 100 that will be invested in the mutual fund.