Investor Interest   Exclusive
Why don’t funds promote trail commissions instead of upfront commissions?
The reason is they are beholden to large distributors to sell their schemes. And these distributors are more interested in churning and therefore upfront commissions. They have no interest in promoting long-term investment in equities and earning from trail commissions
 
Upfront commission paid out by mutual fund houses to distributors has always been a bone of contention. Last year, industry body Association of Mutual Funds in India (AMFI) scrapped the plan to ban upfront commission. Last year, after the market regulator brought out a slew of reforms to ‘revive’ the fund industry, we mentioned that independent financial advisors (IFAs) contribute the most to new equity fund inflows especially from beyond 15 cities and yet the regulator chooses to ignore this ‘small’ distributor community by coming up with regulations that harm their business, allege smaller distributors (Read: Mutual fund regulations: Who contributes the most to equity inflows is overlooked). Trail commissions, though lower than the one-time upfront commission, support their business model as they establish long-term relationships with their clients. Distributors, on the other hand, look to earn higher in the form of upfront commissions through excessive churning of their clients’ portfolio. This practice in not only damaging for the client but affects the industry as a whole.
 
Chilukuri KRL Rao, a small distributor from Hyderabad, has drawn our attention to the ground-level practices that hurt investors and smaller distributors. He says, “Small distributors who cater mainly to the small retail investors are willing to work even with low trail commissions due to their cost efficient business model. But, the main hindrance to the growth of the industry seems to be the way these incentives are being paid to a distributor.”
 
A number of independent financial advisors (IFAs) also support a ban in upfront commission. “High upfront commissions lead to the practice of excessive churning by unscrupulous mutual fund distributors in order to earn themselves a higher commission. This practice of fund houses offering a higher upfront commission and lower trail commission is detrimental to many honest distributors who promote investing in mutual funds for the long-term. They lose out as because of the upfront commission they earn lower in trail commission,“ points out Rao.
 
Trail commission is beneficial to distributors who are able to keep their clients invested in a particular scheme for the long-term. In the table show below, Mr Rao shows how small distributors benefit in the long run with just trail commission. The table portrays a trail only model of Franklin Templeton Mutual Fund where in they pay a trail of 1.1% perpetually. Distributors lose out on earning a higher commission from the second year onwards when they earn a high upfront commission.
 
Many other IFAs support this “trail only” model by Franklin Templeton MF. In a discussion forum on wealthforumezine.net many IFAs have voiced their opinion on the “trail only” commission model. Vikas Gupta, a distributor from Rohtak says, “I am of the firm opinion that upfront brokerage must be banned in MF industry to curb all types of mis-selling and trail commissions might be increased accordingly to boost ethical selling.”
 
Another IFA from Mumbai, H Manohar Shenoy, says “Trail model is the best method, as one is required to sell the right product in a right way. This will enable an investor to remain invested longer. It is in the interest of IFAs and the mutual fund Industry. Upfront commission, as we all know, encourages bad practices.”
 
For retail investors as well, this would be beneficial as distributors will not be lured to offer them schemes having a high upfront commission and/or ask them to churn their mutual fund portfolio on a regular basis. Moneylife has written several times in the past on this unscrupulous practice. Recently we saw certain fund houses paying an upfront commission as high a 6% to distributors for their RGESS (Rajiv Gandhi Equity Savings Scheme) eligible mutual fund schemes.. Hence, to earn a higher income, distributors would naturally pitch the schemes. These schemes saw applications as high as Rs10 lakh coming in from HNI clients. (Read: High value applications perverting RGESS, while SEBI remains mum)
 
We had earlier reported on how fund houses were paying upfront commissions for ELSS (Equity Linked Saving Schemes) and other schemes to garner assets. (Read: Upfront commission being granted for ELSS schemes and MIPs become attractive for distributors due to upfront commissions) Upfront commission as high as 3% was being paid for ELSSs and 1%-1.5% in the case of MIPs (Monthly income Plans). 
 
Banks have also been accused of excessive churning of client portfolios. We had highlighted this in November 2010, (Read: Now, banks blamed for continuous equity mutual fund outflows!) where banks were excessively churning mutual fund portfolios to earn commissions. But even then neither the fund companies nor the regulator seemed concerned.
 
Why don’t large distributors support the ban on upfront commissions?
Fund houses usually pay 0.70 to 6.5% as upfront commission to distributors to push their equity schemes. This is an additional amount of money which AMCs pay from their own pockets to distributors. Apart from this fund companies pay a trail commission as well which ranges from 0.4% to 0.6%. This huge difference in commissions makes larger distributors resort to excessive churning in order to earn higher in the form of upfront commissions.
 
According to Mr Rao in his letter, “Trail only model benefits investors and small distributors whose assets are known to be for a longer term. Influential distributors get a far higher upfront commission than what a small distributor gets and hence, this is one of the main reasons for not doing away with upfront commissions.”
 
Supporting this fact, Subhash Chander, a distributor from Rohtak in a discussion forum on wealthforumezine.net says, “National distributors get lot more than IFAs as upfront brokerage, contests, overseas trips, gold, movie tickets, pizza parties & more trail while IFAs have to be satisfied with lesser trails second year onwards.”
 
Mr Rao also mentions that top fund houses which can afford to pay huge upfront commissions to promote their schemes may not go in for the “only trail” model and increase the trail commissions, as paying of trail commissions would reduce the profitability of the fund house. Also, there is lack of transparency in the upfront commissions paid to distributors. Therefore, some unscrupulous elements would use this to their benefit. “Trail commission is well published and transparent; hence, the scope for such manipulations is almost nil and is not a very profitable option for such unscrupulous elements,” says Mr Rao.
 
Even KN Vaidyanathan, an executive director of SEBI, in an exclusive interview to Moneylife in May 2010, on the ban on upfront commission in the form of entry load, spoke about the benefit of a trail only model saying, “People confuse between upfront and trail. Business models based on upfront will die. Irrespective of how the dispute between ULIPs versus mutual funds works out, the writing on the wall is clear. Upfront commissions and entry loads will become zero. It is a matter of time. Therefore, what it leaves us with is trail commissions. There is nothing to match the attractiveness of trail commission of mutual funds because the trail is on the total kitty, not like the upfront commission on a single product. But that means everybody has to think long term, especially after upfront commissions are gone” (Read: “Upfront commissions were making everybody think short-term. They will think long-term now”) 
 
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    COMMENTS

    Nilesh KAMERKAR

    7 years ago

    One of the distributors has written (an email). He has urged other fellow distributors to comment in favour of only trail model.

    Fixing seems to be the flavour of the season ...

    kolliparabharatkumar

    7 years ago

    Upfront commissions are root cause of almost all the ills of the Mutual Fund industry and I have no doubt that as long as there are upfront commissions honest/small distributors and investors will be at a dis-advantage and the industry can not inspire the kind of trust required for mass participation of investors. Hence I request the regulator to Ban upfront commissions.
    Trail only model should be encouraged to give a stable & reliable income for distributors so as to increase their confidence about their livelihood. Once the industry can instill that confidence number of active distributors will increase (from the current 5000-10000) which in turn helps the growth of the industry.

    Vikas Gupta

    7 years ago

    A very god article from IFAs, Investors & Ethical selling point of view. Upfront commission must be totally banned to curb maximum types of misselling.

    Ramakrishna K

    7 years ago

    I agree to the Trail only model Where regular stream of income flows. The upfront keeps us always on the race and prompts us for ill / wrong practices, as the big institutions are following. As commented by few its the regulator which needs to choose the way it wants, to curb the churning, take care of the distributors / retain them and healthy growth of mutual funds promotion.

    MUPPURI SUBRAHMANYM

    7 years ago

    Whoever entering the Mutual Fund industry as a distributor fully understands that it will be impossible to survive distributing only mutual funds in the initial phases and it becomes compulsory that we distribute other financial products like Health, Motor, life insurance etc., to survive the initial phase. So, it becomes a question of how quickly we new distributors break even in this business (meeting expenses-both family and business)and turn it profitable.



    I have started my business in upfront model about Two years ago and I am still not breaking even because of the low commissions from the second year on wards. Had it been a Trail only model we can reach break even point in about 3 years. But with upfront model the break even point will be after 5 years only and that too is dependent on the regulator as he may cancel all commissions if irritated by churning that happens due to upfront commissions.



    Moreover, if monthly lower income(in trail only model) is an issue then having no income at all due to claw back for months together(due to claw back, many distributors are getting zero brokerages/negative brokerages) is even worse. Upfront commissions take certainty out of our income streams and don’t let us plan our own finances in a proper manner.As long as upfront commissions are there small distributors/honest distributors will be paid low Trail commissions, hence I request the regulator to ban upfront commissions and encourage honesty.

    DB DESAI

    7 years ago

    I am in favour of upfront plus trail model. The problems generated out of higher upfront should be dealt with some other innovative measures rather than banning upfront and depriving of the small distributor from getting his rightful remuneration for introducing a new investor or new investment to mutual funds. There is definitely a case for upfront commission. Do we have a doctor who takes money only after the patient is cured? Any advocate taking fees only when the case is settled and the client wins? Any builder, architect, travel company, school, tutuion class, magazine subscription takes money only after buying their product or service and only when the customer is satisfied? You are satisfied or not there is some cost involved before manufacturing or providing the service which should be recouped? And in all cases of any product or services the end user has to pay. Does the Govt. collects tax after providing the civic amenities from the citizens? Whatever is offered free is said to be dangerous by experts. Why only mutual fund distributors are singled out to work for free and wait for their dues. What if there is subsequent switch, change of broker, redemptions, change of rules, end of mutual fund industry or anything unknown comes into existence? Who will then pay the distributor? This idea is coming only because nobody is able to think of any other way of curbing the malpractices. I am fully in support of eliminating such bad practices from the industry but not at the cost of the small retail individual distributor and more so for those who are working in remote area where noboday has dreamt of reaching. Commission is not extracted from the AMCs by the distributors. Big distributors are paid by AMCs then action should be there against such AMCs and not against the distributors. There should not be any relation of industry growth at the cost quality of growth. I hope someone will see the issue in right perspective and put forth the arguments.

    REPLY

    DEEPAK KHEMANI

    In Reply to DB DESAI 7 years ago

    Very well said fully support your arguments/points raised by you.

    Thomas Verghese

    7 years ago

    Trail commissions would help in minimizing the churning of Portfolios. It would also help the investor as the Distributor would give honest advice instead of being tempted by additional upfront commissions each time a change in portfolio happens.

    Rajiv Jhaveri

    7 years ago

    Churning is done only to get higher payout of First year. It is beneficial only if higher payout is paid in first year. These activity can traced easily by calculating life of assets of all distributors. Amount is redeemed after one year & then invested in other scheme to earn one more higher payout of first year. Automatically life of assets of those distributors(churners) will be low. Even in the only trail structure shown above churning is beneficial in B-15 areas, as they are offered 2.6% in first year & later on 1%. So the only best solution is uniform rate for all years. It is the need of the hour to implement uniform rate of commission for all years not only in MF industry but also in Insurance products.

    T KUMARA SWAMY

    7 years ago

    It is obvious that the kind of obscene upfront commissions that are paid to some big distributors are not sustainable especially when one considers the fact that some of these distributors may be churners too.
    To pay these high upfront commissions for these un-scrupulous elements, small / honest distributors are being short changed. This un-ethical practice will stop only when upfront commissions are banned. Request the regulator to ban upfront commissions to remove the corruption associated with the industry once and for all.

    Suiketu Shah

    7 years ago

    The mutual funds industry rules,regulations,etc are so so anti-customer that it is best to stay away from this product.Invest in govt bank FD's or shares as suggested by moneylife only.(not anyone else)

    It is basically these fraud and cheat wealth management companies like HDFC Bank Investment banking division in Lower Parel(headed by sodapop Parimal Shah),etc who have ruined the mutual fund market and any remedial actions at this stage is too little too late.

    ashok sen

    7 years ago

    I just dont understand the distributors.
    They exist because the client is there.Just because most clients understand little of the commission bit,does not mean the distributors take them for a ride.
    Dont the distributors understand that following the trailing commission method, will make the customer earn better returns,as the distributor will not simply make him invest in a fund and run away,having earned his commisssion.
    If the customer gets good returns,he will invest more,and inform others to do so.

    Vaibhav Dhoka

    7 years ago

    It is AMC oriented payouts.Those with bank connection give upfront and therefore churning is high in such cases.

    DEEPAK KHEMANI

    7 years ago

    There is really no real solution to this problem.
    All distributors/advisors are not the same, some may have just started some may be in this Business for many years, it differs for a newcomer something in the hand upfront after spending time and effort will be worthwhile for others asset stickiness may be fine, I think all MF's should have a twin model in which the Advisor decides what is OK for him and then takes it forward.
    For large distributors and Banks it is a different story altogether.

    Nilesh KAMERKAR

    7 years ago

    Disagree.

    How long can new entrants survive with an only trail model? ( Only trail will be one more entry barrier )

    Will fund houses apply the same logic to remunerate their fund managers & other key personnel too?

    How many of us will be willing to accept such an arrangement for our own selves? (sweating already at just the thought of it...)

    R Balakrishnan

    7 years ago

    Very valid observations. Even as an AMC, one has to fall in line. Change has to start from the big boys- HDFC, RIL, Templeton, Reliance etc. If they move to full trail, others will.

    BOI AXA Equity Debt Rebalancer Fund: A dynamic scheme aiming to time the market

    A handful of dynamic schemes vary their allocation to equity according to a pre-defined formula. Some of these schemes have done no better than any other equity diversified schemes. Would the new scheme from BOI AXA Mutual Fund be any better?

     
    Last year, Bank of India re-entered the mutual fund business by acquiring 51% stake in Bharti AXA Mutual Fund. Now known as BOI AXA Mutual Fund, the asset management company is probably planning to set itself apart by launching schemes different from that of other fund houses. Earlier the fund house filed offer documents for hybrid schemes with gold as an asset class—BOI AXA Gold Income Stabiliser Fund and BOI AXA Triple Asset Allocator Fund. The company recently filed an offer document to launch an open-ended dynamic asset allocation fund—BOI AXA Equity Debt Rebalancer Fund. The fund will invest in two asset classes namely; equity and debt securities. Similar to the Triple Asset Allocator Fund the proportion of the portfolio invested in equity or debt is determined based on the month end price-to-equity (PE) ratio of the CNX Nifty Index.
     
    The scheme has the flexibility to vary its allocation in equity and debt from 10% to 90% depending on the PE ratio of the Nifty index. “If the valuation of the broader market measured by PE ratio is high, the fund will take greater exposure to debt and vice versa. The proportion between equity and debt securities is determined by PE bands,” mentions the offer document. The allocation would be defined as per the table below:
     
     
    Does the scheme make sense? 
    We have analysed such market timing schemes in the past. (Read: Dynamic Plans:Dart-throwing) The schemes which invest based on PE valuation of the CNX index have done relatively well compared to other schemes. However, the proportion of equity to debt of all the three schemes vary. Therefore, even the fund houses are divided on an optimum allocation at a particular PE. Another important factor that would affect returns is the stocks selection of the scheme. For the equity portion of the new scheme, stocks would be chosen out of the top 100 companies by market capitalization listed on the National Stock Exchange and the Bombay Stock Exchange. What if the PE of the overall market is low but that of stock selected is high or vice versa? Stock selection would impact the performance of the scheme, maybe even negating the . A better way would probably be to use a market-timing strategy along with a top mutual fund scheme (Read: SIP vs Market-timing)
     
    Alok Singh, chief investment officer-fixed income, would manage the debt portion of the scheme and has seven years of experience in the mutual fund industry. Gaurav Kapur, who has just five years of experience in research & fund management, would manage the equity portion.
     
    Other details of the scheme:
    Benchmark : CNX Nifty: 50% + Crisil Short Term Bond Fund Index: 50%
     
    Load Structure:
    Entry Load – Nil
    Exit Load – 1% if redeemed within one year from the date of allotment
     
    Minimum application amount:
    Rs5,000 and in multiples of Re1 thereafter
    Minimum Additional investment:
    Rs1,000 and in multiples of Re1 thereafter
    Investment through SIP/STP:
    Monthly SIP: Rs1,000 and in multiples of Rs100 thereafter
    Minimum duration: 12 months
     
    Expenses:
    Maximum total expense ratio (TER) permissible under Regulation 52(6)(c)(i) and (6)(a): Up to 2.50%
    Additional expenses under regulation 52(6A)(c): Up to 0.20%
    Additional expenses for gross new inflows from specified cities: Up to 0.30%
     
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    Mutual Funds: Debt ULIPs Popular; Stay Away

    ULIPs (unit-linked insurance plans), which went out of favour after the IRDA brought changes in the structure of the product, have become popular over the past six months. But debt ULIPs are doing better. Intermediaries are pushing this product with the story that interest rates will decline and that will boost returns. Are debt ULIPs the right product to buy? Not with average returns and...

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