The 5th devil of distribution business

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Ashish & Manish Goel, Vista Wealth, Delhi

(Views expressed are after internal discussion with most DFDA members and externally with many other IFA associations along with stand alone IFA thought leaders.)

Even as distributors are busy fighting against the 4 devils of distribution that we outlined earlier (Click here), a fifth devil has now emerged – deduction in old trail commissions – the infamous 15 bps reduction in trail across the board on all assets, new and old. This one honestly hurts the most as the manner in which it has been implemented has left many IFAs disillusioned about the whole spirit of partnership that our fund houses keep talking to us about.

Why this one hurts the most

Lets go back to the origins of this whole saga to understand why we are so hurt. In October 2012, SEBI came up with a series of changes meant to “energize” fund distribution. One of the measures was an increase in TER by 20 bps in lieu of exit loads being credited into schemes rather than taken into AMC books. This TER was increased at scheme level, which means that the benefit accrued to fund houses on the entire AuM – old assets as well as fresh money that came in after implementation. Not a single AMC came to us that time and offered to increase our trail commissions on old assets although they got that benefit in their books. Instead, we were offered higher trail on fresh business only.

As all established distributors know, trail commissions moved up in three phases – always on incremental assets only. Old assets (entry load era) were the lowest, then a higher slab between 2009-2012 and then a higher slab post 2012. This continues to be the case even today. We receive 3-4 levels of trail commissions from the same fund house, depending on vintage of assets – the older, the worse. When we approached all fund houses post 2012 and asked them to revise old trails, particularly since they were allowed fungibility in expenses, most declined to do so and encouraged us to go out and get fresh money at higher trail commissions. Some who tried to accommodate were soon put in place by an AMFI guideline that specifically prohibited increasing trail commission on old assets.

Now, SEBI came up with a decision to cut that 20 bps to 5 bps because data is showing that exit load amounts actually being credited into schemes is not exceeding 5 bps. TER has therefore been reduced by 15 bps. Let’s understand one thing – SEBI’s decision is about reducing TER due to actual data on exit loads – it didn’t say anything about reducing distributor commissions.

The moment this 15 bps TER reduction was announced, some fund houses communicated to distributors saying that AMFI has decided that trail commissions be reduced by 15 bps on all assets and hence decided to cut our trail commissions on all assets – including pre 2012AuM. Many AMCs did this, some AMCs attempted mid-way solutions, some have decided not to pass on any reduction (they are really seen as distributor friendly AMC) and there is still some confusion on how some AMCs intend going forward on the 15 bps issue.

5 points for fund houses to consider

We have five points to make in this context:

  • The thinking that SEBI’s decision to cut TER means distributor commissions have to be cut is deeply flawed. SEBI never said this – it is a decision made by fund houses and endorsed by their own trade body (AMFI), and is being differently implemented by different fund houses. Reduction in trail is not a regulatory decision, as some are trying to portray.
  • Reducing trail on pre-2012 assets is plain wrong and cannot be justified under any circumstances. When AMFI stopped fund houses from increasing trail on old assets, how can it now with any conscience, suggest that trail on old assets has to be reduced? Is this the partnership model that fund houses keep talking to us about? We also hear this argument very often from fund houses, that anyway old assets is a very small percentage of AuM, so why are IFAs shouting themselves hoarse on this. This again is factually incorrect. Speaking for ourselves, over 20% of Vista Wealth’s AuM is pre-2012 assets. We didn’t churn it like some other distributor channels do, because we did what is right for our clients. Now, we are getting penalized by seeing 50 bps trail reducing to 35 bps trail on assets that we have helped stay with these fund houses for so many years, while these other distributor channels simply churn away old assets to keep improving their revenues. So is this the message we have to take away from fund houses – churn to resolve the issue?
  • If the issue is about where to find savings to compensate for the 15 bps loss in revenue, and you expect some part of it to be borne by distributors, first cut down on foreign trips and then touch trail only if you find the savings inadequate. As it is, the amount of foreign trips that are happening this year is excessive and it is catching regulatory and media attention. Most fund houses say these are not encashable – so those who don’t want these jaunts get a raw deal. If we are both genuinely long term partners, we should look after each others’ long term interests – distributors should provide sticky long term assets rather than churning to boost short term revenues and fund houses should do everything to protect long term distributor earnings and sacrifice short term incentives if they have to cut somewhere. What is happening is the opposite – the message from fund houses is go ahead and churn to solve your old assets problem and when you do that, we will take you on a foreign trip as well to reward you for gross sales during the year you churned!
  • We will readily agree with fund houses that trail commissions in the last 2 years have indeed increased substantially. Whether it is due to valuation related pressures from fund houses leading them to pay higher for market share, the fact is that market forces have resulted in trail commissions increasing on fresh assets. In our view, a fair and equitable way of asking distributors to bear their share of the burden of 15 bps cut in TER will be as follows:
    • Trail commission below 1%  no change, no cut
    • Trail between 1.00% – 1.25%  reduce trail by 5 bps
    • Trail between 1.25% - 1.50%  reduce trail by 10 bps
    • Trail above 1.50%  reduce trail by 15 bps
    We believe this should be used as a last resort, after fund houses have genuinely explored every other avenue to effect cost cuts to pay for this 15 bps TER reduction.
  • We want fund houses to appreciate that the entire GST burden has anyway fallen on us and we have already taken a haircut of 18% in our gross revenues. When fund houses talk about commissions approaching distributable TER, this is a gross commission. When fund houses talk about 1.50% trail, it actually is 1.27% net of GST. It is the inability of the industry to convince the regulator to enable tax on commissions to be added to TER (like they do for management fees) which is resulting in us having to bear this load. It is this which makes commissions appear at least 18% higher than they actually are. In every other business, commercials are agreed at a rate plus GST. Ours is one of the few where the rate agreed is inclusive of GST. After taking an 18% haircut on all trails (including old trails that are not high), to expect us to take another 15 bps cut on all trails makes the burden too high – especially for IFAs who build long term sticky assets. Fund houses ought to understand which distribution channels work for the investor and which for themselves and devise mechanisms that transmit the pain of trail reductions in a manner that promotes doing what is right for the investor rather than tacitly encouraging what is not.

Very important to get this one right

We sincerely hope that fund houses will walk the talk on building partnership based relationships, and do what is right to manage this 15 bps TER reduction. This becomes all the more important as there is a belief that in the coming years, as volumes grow, TERs will come down. How the industry manages this round of TER reduction will set the tone for the future. It is important that the precedent set today is the right one – not one that tacitly encourages churn by turning a blind eye to the gross injustice of an across the board reduction in trail commission to the exact amount of reduction in TER.

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