Mutual funds: Fund & games
R Balakrishnan | 27 February 2014

In the old days, when one invested in chit funds or fixed deposits, the distributor would give you a gift of some kitchen items like plates or tumblers or some small item of daily use. The same set of people got into the mutual fund industry and the practices have continued. The only difference is one of scale—not of principle. The Association of Mutual Funds of India (AMFI) and Securities and Exchange Board of India (SEBI) can live in denial saying that they have banned this, but it never stopped. It only stopped for the ‘small investor’ who demanded his share of the agent’s commission. The big distributors have the resources to gain market share; but they cannot do it forever. The independent financial advisor (IFA) can ill afford to pass-back if he has no other stream of revenue.

Suddenly, there is a huge clamour to ‘protect’ and ‘save’ the small distributor and bring back small investors. The mutual fund industry, the independent financial advisors (IFAs) and everyone else seems to think that the prime minister will do this as if India’s economic future depended on this.

At the same time, AMFI has come out with some data (I do not think it is very reliable or complete) that shows the commissions ‘paid’ by fund houses to various distributors. It does not prove anything conclusive, but it clearly shows that mutual fund distribution is getting dominated by the banks that know how much the customer has in his bank account. They also enjoy (not correctly) a higher degree of clients’ trust, as opposed to other classes of sellers of financial products. So, it is natural that banks will emerge as the largest sellers of financial products.

There is also some lament that banks will always give preference to products churned out by the fund company of the group. This is also a natural conclusion and happens in every industry. No one gives a damn whether it is fair or unfair. In fact, in the mutual fund business, one thing is clear. Shelf space has to be ‘bought’ by fund houses. Performance and selling are not related.

In the past few years, the other big change that has come about is the control of corporate business by the fund houses directly. The distributor, in any case, had no role in the corporate mutual fund investments, other than facilitating kickbacks, pass-backs and freebies. For this facilitation, they would get to retain a portion of the commissions. This used to be significant, since the amounts invested were large. For example, if a bank put Rs1,000 crore in liquid funds for two months, the total commissions would be of the order of around Rs16 lakh. The agent could retain anything from Rs1.6 lakh to Rs8 lakh on this deal. Now, the fund houses have the entire database of clients and also know each client’s weaknesses. So they handle it themselves and use agents only when the kickback arrangements are very strong between the agent and the investor company executive/s.

Fund houses offer different kinds of incentives. Normal ones include foreign trips, educational trips, picking up air tickets for family holidays, ‘advertisements’ that may or may not get published, sponsoring educational off-sites, tickets for IPL, gold coins, ‘training’ camps at exotic locations, business meetings and other unmentionables. No avenue is left unexplored. I know of cases where the fund houses give out Sodexho gift vouchers to clerks, officers and managers in banks and other corporates on a monthly basis. The amounts can range from Rs2,000-30,000 per month. In return, the executives ensure that investments are routed to specific funds, in proportion to the gratification received from them. Gold coins have proven very successful when there is a lady at a critical desk in the whole chain.

If the income-tax department were to go through the Sodexho voucher purchases by asset management companies and checks with in-house employees about whether they actually got them, it would open a Pandora’s Box. Corruption is the same in public and private sector companies. In fact, corruption in the private sector is higher than what prevails in public sector companies. This practice by big distributors extends to their seeking investments from high net worth individuals (HNIs). In fact, I know of many HNIs who are in direct touch with fund houses to find out the freebie scheme going on at anytime. They then ask the fund house to appoint a distributor who will arrange the pass-back. I know of HNIs who have gone back to the AMCs and asked for ‘cash’ equivalent of the free air ticket—and got it!

So, the race for the assets under management continues with no holds barred. The small IFA stands little chance. Bank distributors, with their ability to know what the client has (violating all secrecy laws and the Reserve Bank of India allowing it), have an edge that cannot be wished away. The IFA has to survive on the basis of personal rapport rather than knowledge. Other distributors survive either by serendipity or because they are willing to match the practices of large players. The selling business has become really messy.

In this, the big investor calls the shots. He can decide who to give the business to. Alas, if the investor is small (say, with an SIP of just Rs5,000 per month), the distributor has no interest in him. Maybe an IFA will chase him if he can be persuaded to go through the ECS route. No one can afford to go to him, spend time with him and visit him every month to pick up his cheque for a measly Rs5,000. The gross earnings from him will be just around Rs50 per month and a small growing trail. He is a loss-making proposition for any distributor.

If you are wondering about the ethics in this whole thing, I urge you to forget it. Everyone is curious to know what the other person makes when there is a transaction. We want to analyse and discuss what some distributor has made by selling mutual funds. This is not transparency but voyeurism. What good will these disclosures do?

In the financial services business, it is important to remember that the biggest flows of money are caused by people who are not personally impacted by the outcome of the invested money. So, it is natural that personal motivation in the form of freebies and bribes plays an important role in directing the flow of money. In the Western world the same thing happens. They, of course, use a very sophisticated term called ‘soft dollar’ commissions.

Even at Tirupati, people pay bribes to have a longer glimpse of the idol or to get some rooming arrangement. When the PM, the financial sector and officials talk of bringing back small investors or about the growth of mutual fund business, they are being naive and ignoring some unsavoury truths. The PM cannot ‘save’ the fund industry. Only markets can. Let the bull markets resume and the small investor will rush in like moths to a flame. Maybe he/she will get tempted when the Sensex crosses 21,000.