Do Fund Companies Dislike Direct Plans?

Recently, I had a rather curious interaction with a fund company. Promoted by a public sector bank, the fund company ranks among the larger ones in the industry.

I invested in an equity fund opting for Direct Plan; as per norm, the payee on the cheque was: XXXX Fund – Direct Plan – Growth; the same was explicitly mentioned on the transaction slip as well. Oddly, the statement of account revealed that I had been allotted units under the Regular Plan.

Assuming that it was a clerical error, I wrote an email to the fund company explaining the facts of the case. To my surprise, they wrote back saying “With regards to your query, we would like to inform you that a broker code (ARN Code) was mentioned in the application submitted by you, hence we allotted the units in regular plan. We request you to kindly contact with the respective branch for further assistance.”

I haven’t engaged a distributor for several years now. Furthermore, even if that were the case, the fund’s Scheme Information Document (SID) states that in cases where a broker’s code is mentioned and the plan mentioned is ‘Direct’, the default plan is deemed to be ‘Direct’.

In effect, the fund company had violated its stated guidelines.

After a significant back and forth over email and several tele-conversations, the fund company grudgingly agreed to modify the plan from ‘Regular’ to ‘Direct’.

This episode got me thinking about why my investment had been earmarked under the Regular Plan instead of the Direct Plan. As was evident from the email, it wasn’t an oversight. Rather, the fund company staff was following laid down procedure. Simply put, they had been instructed to act in a manner that was in contradiction to what the SID stated.

But why would a fund company indulge in such skulduggery?

It is common knowledge that despite Direct Plans having been in existence for nearly four years now, a bulk of mutual fund assets continue to be garnered by distributors under Regular Plans.

Moreover, Direct Plans have a lower expense ratio as compared to Regular Plans since distribution expenses et al are excluded. Also, no commission is paid to distributors under the Direct Plan.

In other words, assets under Direct Plans can’t be utilised to compensate distributors. Sadly for some fund companies, that’s unacceptable because in their books, distributors are more important than investors.

Don’t get me wrong. I’m not making this out to be a 'distributor versus investor' debate. However, the fund company has done so, by creating a mechanism to surreptitiously transfer investments from Direct Plans to Regular Plans.

Distributors have an unquestionable role to play in the mutual fund industry. Fund companies are entitled to utilise their services and compensate them as deemed fit. However in their zest to provide for distributors, investors’ interests shouldn’t be compromised.

Investors on their part must evaluate a fund company’s pedigree while making investment decisions. Fund companies that fail to watch out for investors should be steered clear of.

Why Investors Must Cheer SEBI’s Initiative On Mutual Fund Disclosures

Last week, market regulator SEBI released a circular that among others, enhances mutual fund disclosures. The new directives have the potential to be game changers.

Let’s start off with the disclosure that has garnered most attention—commission paid to distributors. SEBI has ruled that henceforth half-yearly account statements sent to investors will have information regarding commission paid to distributors. Commission has been defined to include both monetary and non-monetary payments made by the fund company to the distributor. Furthermore, the statement will also have information regarding expense ratios (for both regular and direct plans).   

Some quarters are up in arms against this ruling. While some feel that disclosing commission-related information will push investors towards direct plans, others argue that this is a conspiracy to ease out small distributors. I believe the reservations are a case of stretching the point.

Fund companies pay commissions to distributors for selling their products (and rightly so!); all they need to do is disclose the same to investors (who bear the cost). No one’s suggesting that fund companies must stop compensating distributors. Also, to assume that an investor who is satisfied with his distributor’s service, will turn his back on the same and opt for a direct plan, because the commission is disclosed is a fallacious argument. So long as the distributor adds value, the investor will continue to be associated with him.

In the confusion, most have overlooked what to my mind is the most important ruling—investments in funds by portfolio managers and other personnel. From May 2016, every fund’s Scheme Information Document (SID) will have information related to investments made by the fund’s portfolio manager(s), the AMC’s Board of Directors and other key managerial personnel.

The rationale behind this move is to encourage the concept of ‘skin in the game’. The concept is far more common in the West, than in India. For instance since 2005, the U.S. Securities and Exchange Commission has required fund companies to annually disclose how much portfolio managers invested in the funds they run. At its core, 'skin in the game' is about inspiring confidence in investors. Managers who invest alongside their investors show conviction in their investment approach and acumen. It’s a classic example of putting one’s money where the mouth is. This regulation offers investors insights into funds, and the opportunity to evaluate them in a manner hitherto unavailable.

Then there’s the directive on soft-dollar arrangements. So far, investors have been blissfully unaware of soft-dollar arrangements between fund companies and brokers, and how the same impacted their investments. SEBI has decided that henceforth, soft-dollar arrangements will be limited to benefits that are in the interest of investors, and the same shall be disclosed.

Admittedly, some rules seem odd—it has been mandated that compensation of the fund company’s top brass be disclosed. Likewise, fund companies will have to publish a list of employees whose annual remuneration is equal to above INR 6 million, and also the ratio of CEO's remuneration to median remuneration of employees. I fail to see how these provisions can help investors make better investment decisions. Investors’ interests would have been better served if the method of computing annual remuneration had been disclosed. That way, investors could have comprehended what fund company top bosses are mainly compensated for—growing assets or fund performance.

That said, all in all, the mandated disclosures have the potential to usher in an era of transparency in the mutual fund industry. However, one must understand that a disclosure (read transparency) isn’t an end in itself. Learning more about funds should translate into informed investment decisions, and in turn, goals being achieved. The onus to make the most of the information on hand, lies on investors, advisers and distributors alike.