Fee cut to pinch smaller AMCs, distributors

The Securities and Exchange Board of India’s (Sebi) move to cut expense ratios and ban upfront commissions could come as a blow to distributors and smaller fund houses.

Experts say retail investors could miss out on access to advice if advisors don’t find mutual fund (MF) distribution a viable business.

While larger fund houses are better placed to absorb the overall cut in total expense ratio (TER), the impact on smaller fund houses with a limited profit pool could be higher, according to the chief executive officer of a mid-sized fund house.

The markets regulator on Tuesday capped the maximum limit on expense ratio at 2.25 per cent, from 2.5 per cent earlier. While this limit is for open-ended equity-oriented schemes, the TER reduction has been announced across categories. Further, Sebi has said the MF industry must adopt the full trail model of commission and has barred upfront commission, except in case of systematic investment plans (SIPs).

In a research note, CLSA analysts said the cut in TERs could have a 25 per cent impact on the MF industry’s earnings. The TER change “will have direct negative impact on overall revenue yields for most AMCs in the industry", according to analysts at Emkay Global Financial Services.

Markets are already factoring in the earning cuts, with shares of HDFC MF and Reliance Nippon Life MF closing at record lows on Wednesday after posting their biggest single-day fall since listing. Distributors fear they will once again have to do the heavy-lifting, as industry tries to absorb these cuts. According to analyst estimates, when Sebi cut additional expenses by 15 basis points (bps) in May, fund houses passed on 70-100 per cent of the impact to distributors. Certain fund houses say distributors will again have to

bear at least 70-75 per cent of the fresh cut in TER.

“The blanket ban on upfront commissions makes it a double-whammy for distributors, especially the smaller ones that have recently entered the industry,” said Dhruv Mehta, chairman of Foundation of Independent Financial Advisors (Fifa), a body representing financial advisors and distributors.

In absence of upfront commissions, small distributors may find it challenging to break even, as building a large asset base is a long-drawn process, say experts.

“All of a sudden, the new entrants will have to take a relook at their fundamental business assumptions if they want to stay in this business. It typically takes seven years to break even in the distribution business. However, it may now take as much as ten years. It wouldn’t be surprising if several distributors decide to exit,” Mehta added.

“Given the smaller ticketsize of SIPs, even if some kind of upfront commissions are allowed, it would do little to recoup client acquisition costs that are incurred on SIPs,” said another distributor.