Static margins prompt Sebi to tweakMF commission

The Securities and Exchange Board of India (Sebi) has raised the red flag on large fund houses’ range-bound profit margins while rationalising the total expense ratio (TER) for the mutual fund (MF) industry.

In the board meeting agenda note on review of total expense ratio (TER) of MF schemes, the market regulator said the reason for the lack of meaningful margin expansion at large asset management companies (AMCs) could be because of large commission payouts to distributors.

Last month, Sebi had announced new slabs for charging TER. Equity schemes with assets of up to ~5 billion could charge 2.25 per cent TER. Earlier, regulations allowed 2.5 per cent TER for the first ~1 billion of an equity scheme’s net assets.

“It may be surmised that one of the major reasons for profit before tax (PBT) margins of large AMCs remaining constant is possibly due to a large amount of commission paid from their own books to garner more assets under management (AUMs),” the market regulator said while submitting the proposal for reviewing the TER structure.

According to Sebi data, the PBT margin for large-sized mutual funds has largely been in the range of 41-46 per cent in the last eight financial years. In the period between FY11 and FY18, PBT margin of mid-sized MFs rose from -2.14 per cent to 25 per cent, while PBT margin for small-sized MFs was up from -129 per cent to 0.36 per cent in the same period. Sebi categorised large MFs as those which accounted for over five per cent of industry AUM. Those with AUM between one per cent and five per cent were categorised as mid-sized and those with assets of less than a per cent of the industry AUM were categorised as small-sized.

Interestingly, the growth of mid- and small-sized MFs only made a marginal dent of 52 basis points in large MFs’ market share, which stood firmly at 68 per cent in FY18. Between FY11 and FY18, large-sized MFs saw their assets grow at compound annual growth rate of 17 per cent, a shade below the

growth seen by mid-sized MFs and 233 basis points higher than smaller players.

According to sources, Sebi’s detailed study on the industry’s financials paved the way for the cut in TER.

“When these observations were put before industry participants, there was not much debate as Sebi had done elaborate groundwork,” said a person with the knowledge of the development.

In the board meeting agenda note, Sebi has also flagged off a set of unhealthy practices followed by certain industry participants.

It’s likely that the trend around the world away from government safety nets towards individuals managing their retirement funds will continue to gain momentum. India is no different and because its population includes more retirees, it’d be difficult for the government to take care of them without private market solutions. Globally, the responsibility of saving and investing for retirement has been pushed to individuals. They have to manage their money and live with the consequences of their investment decisions after retirement. In the US and Australia, we have seen this play out. While not in the near- or medium-term, it is going to be true for India as well at a later stage. The responsibility will shift towards individuals. That is where Morningstar can come in. And this is not just an opportunity for us, but for all the stakeholders in India’s mutual fund industry. More and more savers will become investors.

What are some of the global practices that India’s comparatively young MF industry can adopt?

Every market has its own pros and cons. India is still a young market that is growing fast. As the fund management industry gains scale, we are going to see investors benefit as competition and economies of scale drive down costs. Competition itself will be enough to drive efficiency. We can see this globally. Players like Vanguard and Blackrock have been able to bring down their costs by achieving massive scale. Investors win in this scenario, and, by extension, those who serve them responsibly benefit.

What are your business plans in India?

We were helping advisors to build portfolios with the help of our tools. At some point, advisors asked us if we could build portfolios for them. We have created this capability in the US, South Africa, England and Australia, where we manage money and we also run funds in some instances. India is also somewhere on that continuum. While we don’t have any robust plans in India as far as managing money is concerned, we are experimenting with ways in which we can help advisors. For now, we We have seen globally that active management has struggled in recent years. This is because it is a cost issue. When you are competing against a no-frills index option and you lose a long-term orientation, outperforming becomes challenging. Indeed, one must understand that underperformance is part of any active investment strategy from time to time. Nothing goes up in a straight line forever. Coming back to India, the ability to generate alpha is great at present. But, as markets become more efficient in terms of information flow, the level of outperformance would continue to diminish.

How can the distributor/advisor community bring in more value to the table?

Independent financial advisors (IFAs) have a huge role to play in the mutual fund industry. They have a lot of value to add, but the problem is that they are not able to articulate this value. This is not just an India-specific issue, but a global one. As markets become more complex, it is important that IFAs also become more sophisticated. They should be able to guide investors to build long-term wealth through portfolios that are much more diversified in terms of asset class. We’d like to introduce IFAs to more sophisticated tools to deal with this emerging complexity.