Advisor Speak

18 August 2012

Who says direct is a lower cost model anyway?
Dhruv Mehta, Chairman, Foundation of Independent Financial Advisors

imgbd FIFA had represented to SEBI on 10th Aug, when it first heard of SEBI's intentions to consider a direct share class. Reproduced below is the text of its well-reasoned case urging SEBI not to bring in a direct share class, which FIFA believes will further weaken retail investors access to investment advice, as such a move can potentially further reduce an already shrinking IFA community. FIFA also urged SEBI to follow a more consultative and participative approach before announcing such large structural changes.

Now that SEBI has gone ahead with its decision, Dhruv Mehta believes that at the very least, if SEBI is indeed taking a leaf out of the insurance industry - where a lower cost direct channel has been introduced - let them at least be consistent and announce that a lower cost direct share class will be available only for direct online transactions - like what we see in the insurance industry. If an investor goes direct in the offline mode, he will be using the AMC's sales and service infrastructure, which does cost a lot of money for the AMC to maintain. If that be the case, costs of an AMC servicing direct investors in the offline mode may well be higher than what they pay as commissions to distributors - which means there are really no cost savings that actually accrue in the direct mode. A lower cost offline direct model does not exist. If indeed AMCs can operate an offline direct model at a cost cheaper than the commissions they pay to distributors, they would have done so long ago. There would then be no distributors in this business. The fact that distributors exist and that AMCs have not built a direct retail sales force demonstrates clearly that there are no cost savings in the direct mode - so where is the question of passing on cost savings to a direct investor - when no savings exist? He therefore believes that if SEBI has made up its mind to introduce a direct share class - despite the reservations expressed against such a move - it should be restricted to only online direct transactions - where perhaps a case exists of a lower operating cost model.

Here is the text of Dhruv Mehta's 10th Aug communication to SEBI :

From: Dhruv Mehta []

Sent: Friday, August 10, 2012 5:05 PM

To: ''

Cc:; ''

Subject: Introduction of Direct Plans and Prohibition of Multiple Plans

Dear Mr Agarwal

At the outset we would like to thank you for meeting a few members of the Foundation of Independent Financial Advisors a pan India body of IFAs on 10th July 2012.

We gather that SEBI is considering introduction of a Direct Plan for investors which would have a lower expense ratio and no distribution expenses and consequently a separate NAV. At the same time SEBI is currently not allowing FUNDS to have multiple plans for Institution and Retail and insisting on one plan and a common expense ratio and common NAV. The logic of the 2 proposals run against each other

While the first segregates investors on the basis of whether they use distributors, the second segregates investors on the basis of investment size. World over the prevalent practice is based on investment size. In India we are considering banning this but introducing another class.

This could lead to a lot of existing investors who have taken advise shifting to the direct class after taking advise .

We would like to bring to your attention that not more than 6% of the investor invest directly and 94% through distributors/advisors. This move could benefit very large Institutional investors, FII investors and Super HNI who can do investments on their own. We believe it is better to encourage institutional and retail plans first .

It is more important to focus on regulations affecting 94% of the investors.

Also please note that the current AUM of the Mutual fund has been built through distributors who provide their infrastructure and the growth of the assets enables scale of economies which the direct investor enjoys.

We believe that the introduction of a direct plan would have a deep impact on the IFA community as a whole.

The IFA community covers the entire gamut of the investment community, which involves retail clients, high net worth individuals (HNIs), corporate, trusts and financial institutions. Almost all IFAs will have a combination of two or more of these client types and they serve these clients in different ways as per the needs of that client.

We humbly submit that the process and the approach to formation of a particular regulation play a significant role. In order to ensure effective and proportionate investor protection regime. Therefore we believe it is important that :

  • All stakeholders participate in the process of formulation of the regulations

  • All stakeholders understand the impact of the proposed changes especially investors.

  • Educating Investors about the proposed changes

  • Providing transition time

  • Adequate steps to be taken in transition period to ensure fair application of the regulation

The proposed change in regulation for introduction of a direct plan could lead to a significant remodeling of business model of IFAs across the country which will have a deep impact on distribution similar to the ban of entry load.

  • Lack of investment advice for retail clients: With the enforcement of the proposed regulations, even investors investing thru distriburtors will start demanding rebating of distributor trail commissions, which will further reduce the remuneration of IFAs.. This will further reduce the number of distributors servicing investors. We believe that while it is debatable that the regulation will benefit the large clients it has unintended consequence of reducing the availability and accessibility to investment advice for a significant number of predominantly less affluent customers.

  • Post the no entry load regime, small IFAs have been marginalized as they were unable to receive upfront commission from the manufacturer which lead to elimination of many small IFAs. As a consequence, the retail investor base that such IFAs serviced didn't have anyone to advise them during the financial crisis leading to a negative effect on market penetration, this could have been avoided if the market was given some time to adjust to the change in regulation. Similar consequences may occur if market participants are not given reasonable time of at least a few years to adjust to the proposed regulations.

Introducing such a regulation without properly understanding the impact on various stakeholders, will result in complete chaos for many IFAs. The direct impact of such changes will be felt on these IFAs as they will have to devise new business models to continue their source of income. SEBI should therefore consider giving appropriate time to the IFAs to get accustomed to these fundamental structural changes. It is also clear that this measure is not going to lead any increase in retail penetration.

We appreciate if you give us half an hour to express our apprehensions and concerns on Monday or Tuesday .

With Best Regards

Thanking You

Dhruv Mehta


Dhruv L Mehta