There are a number of ways by which we grow our money drop by drop to build at least a lake of wealth for future consumption. After taking care of Wealth protection by way of insurance we recommend delving into Wealth creation keeping Asset Allocation in mind and investing in Debt and Equity to create a long term corpus that will not only help meet our financial goals but also let us indulge in a little bit of luxury if the corpus permits, as an incentive for such long term savings.
The Equity part of the portfolio can be built with direct stock investing or through Mutual funds the latter being the preferred route for a major part of the population as the effort involved in selecting buying and tracking individual stocks not only needs acumen and eye for detail but also time and temperament that many lack. Thus Mutual funds are the preferred route for growing money.
Of the several expenses that one pays to the AMC to manage a scheme there is a lurking element called Trail commission that not many are aware of. Trail commission, put simply, is the loyalty fees paid to the distributor for marketing and bringing the business. This is completely justified because the advisor/distributor has shown the way for a customer to invest in the fund, at times even discussing in length why that particular scheme is a fit for a portfolio [Planners must do this anyways!]. Thus it is right that the distributor gets paid the trail commission. There is a class of investors who go directly with the AMC. Many of them might get tips from newspapers, magazines, blogs and forums and also invest by word of mouth/recommendation received from friends and family and may choose to go DIRECT as well. The AMC charges a trail commission for such DIRECT customers as well. So how do the AMCs do it?
Trail commission can be between 0.2 to 0.8% (no limits but usually sub 1%) for equity funds and much lower for Debt and Liquid funds. Each quarter the AMC deducts the trail commission from the NAV of the scheme. So if the NAV today is 100 and tomorrow due to market movement the NAV raises by 50 paise to 100.50 and a Trail commission of 0.15% (Assuming annual trail of 0.6%) is applied the final NAV is 100.3493 which will be rounded to 100.35. An unsuspecting user would assume that the NAV went up only by 35 paise while the trail has slowly eaten away some returns. Miniscule – one may think. Not really, if you consider this over the long term. Look at the attached spreadsheet here for the actual impact. This can reduce your corpus by over 11% even assuming a MF growth rate of 12% over 25 years and trail commission of 0.15% each quarter. For an initial investment of 2 lacs and continuing a SIP for Rs. 10000 over 25 years the final corpus can get reduced by ~ 25 lacs which would still be decent money after 25 years. Discounting at a long term inflation rate of 8% this amount would be worth 3.65 lacs in today’s terms – not a small amount in any sense. Imagine this money being charged for the thousands of investors!Work out the numbers yourself for your SIP amounts by clicking the excel spreadsheet here.
Outlook Money recently organized a Mutual Fund round table and posed my question to the MDs and CEOs of several Mutual funds who had attended the meeting. You can see the responses right here. Bluntly put the answers have been wishy-washy as you can see for yourself avoiding a sensitive topic in the Mutual Fund world – on one end it says it is impossible to segregate investors and at the other end it says that these funds anyway return higher than compared to the trail being cut. Both arguments don’t hold water for obvious reasons. The AMC perhaps has not done anything to earn this DIRECT customer and it is not justified charging a trail commission to this investor.
In this highly technical world when AMCs can track down right at the point of transaction initiation if the folio’s broker needs to be paid a transaction commission of Rs.0, Rs. 100 or Rs. 150 it is not a difficult task to find out customers who are DIRECT investors. Also just because the fund returns higher one need not necessarily have to pay a trail – something that will be used for the AMC’s marketing expenses. In fact more the return more the trail as well as you saw in the spreadsheet above!. The trail commissions are the customer’s money and AMCs know this.
Is there a solution out? Perhaps yes.
Option 1 – Retain the NAV + Reduce the units held for customers charged with trail commission.
This way the DIRECT investors will see the full value of NAV retained. The customers going through a distributor will see few units shaved off their portfolio reflecting the trail that was paid. This will lead customers to ask questions on the Account statement. Honestly speaking if the Distributor has done the due diligence they deserve this but any money ‘taken’ from someone usually cause rankles. They will all want to switch to DIRECT mode making the MF industry unattractive for distributors.
Option 2 – Decrease the NAV + Increase the units held for DIRECT customers
This is the best of both worlds. This way the DIRECT investors will see the NAV slashed but compensated in the form of new additional units. The customers going through a distributor will see the NAV reduced but as is today many would not even notice while the DIRECT customers do not get penalized.
We as informed investors must write to SEBI and AMFI about this practice. It is not that they don’t know this but perhaps when there is a rise in volume of such requests from informed investors it might be considered and deliberated.
Would the AMCs listen?
Welcoming all your views on this!