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Commission Disclosures: A Half-baked Effort
While the act of disclosing commissions is not likely to be detrimental to the industry per se, doing so in a manner that's so ambiguous is likely to breed distrust between even well-meaning intermediaries who earn wafer thin commissions, and their clients
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The first lot of the much discussed and debated 'commission disclosing' Mutual Fund Consolidated Account Statements rolled in last month. "A little bit of information is a dangerous thing" is the adage that immediately came to mind. Aimed at increasing transparency and empowering investors to make more informed choices, the disclosure (at least in its current avatar), unfortunately does little to benefit investors.
Mutual Fund Distributors make money in three ways: as an upfront pay-out, every time a new investment is made (or a new SIP tranche is debited), as a sales incentive (say, on a per application basis), or as 'trail commissions' which are in direct proportion to the client's assets under management.
A quick glance at a sample CAS (Consolidated Account Statement) send by NSDL to a client recently will leave you surprised at the opacity and oversimplification of the so-called disclosed commission number. It flatly suggests that the intermediary has earned Rs. 143.23 on a total investment of Rs. 13,831 made by the client - approximately 1.03 per cent of the corpus value. Unfortunately, this data has scant significance when viewed in isolation. Was this Rs. 143 charged over the course of the past month (as the footnote seems to imply)? Was it charged over the past quarter, financial year or calendar year? Or was it charged since the inception of the folio? What is the breakup of this Rs. 143 (in terms of trail commission, upfront commission and other sales incentives)? These are just some of the consequential questions that this statement fails to address.
Most clients are likely to infer that this pay-out of Rs. 143 was made to the intermediary over the course of 1st - 30th September, implying that the total commissions over the course of a year would exceed 12 per cent. That would be a preposterous assumption, considering that most Mutual Fund distributors don't realise more than 1.25 per cent to 1.5 per cent of their total Assets Managed as their annual commissions!
The published "total expense ratio" or TER number of 2.31 per cent ups the confusion by another notch - it's worth noting that the TER also includes the moneys charged by the Asset Management Company for their efforts, but it's been lumped together unceremoniously with the distributor commission figure; almost as if to suggest that the distributor commission earned is, by itself, 2.31 per cent.
While the act of disclosing commissions is not likely to be detrimental to the industry per se, doing so in a manner that's so ambiguous is likely to breed distrust between even well-meaning intermediaries who earn wafer thin commissions, and their clients.
After all, the purpose of disclosing commissions is to foster an environment of transparency, build trust between clients and their advisors, and discourage sharp and dubious selling tactics that may be motivated by factors other than client interests. Presumably, SEBI's objective isn't to further weaken the already dwindling 80,000 strong Mutual Fund distribution community, which is part of the rare breed of financial intermediaries that partake in the selling of low-cost financial products that can potentially create tremendous long term wealth for clients.
Disclosures should ideally be made annually, on the folio anniversary, rather than bi-annually. This can help smooth out the aberrations that could arise from one time pay-outs made as sales incentives, which could otherwise grotesquely distort the short term "fees charged as a percentage of assets" number that discerning clients will likely be keenly watching. Additionally, there needs to be a clear division between one time commissions (such as sales incentives) and recurring commissions (such as trail incomes) to paint an accurate picture. Lastly, the statement needs to clearly distinguish the commission earning period, for example: "Commissions earned between 1st April 2016 and 30th September 2016" rather than bluntly representing the Rupee amount as "Commission Paid", without any further explanation.
If this grossly oversimplified disclosure format was drafted in the interest of simplicity and enhancing client experience, it certainly defeats the larger purpose. A re-look at the representation and its format is definitely in order.