MF Maze To Matrix


October 2018

The latest S&P Indices Versus Active (SPIVA) India Scorecard suggests that 88% of Indian equity large-cap funds underperformed their benchmark in the one-year period ending June 2018. Beating benchmark post introduction of total return index (TRI), a benchmark that captures dividend income, has become difficult. Asia Index, a joint-venture between BSE and S&P Dow Jones Indices, runs the SPIVA scorecard. The large-cap equity funds witnessed a low survivorship rate (68%) and a low style consistency (13%) over the 10-year period ending in June 2018. Over the 10-year period, the return spread for actively managed large-cap equity funds between the first and the third quartile break points of the fund performance, stood at 3.6%, pointing to a relatively large spread in fund returns. In line with the historically volatile nature of the mid-/small-cap segment of the Indian equity market, the return spread for actively managed mid-/small-cap equity funds was even higher at 5.1% over the same period. Simply put, the spread in fund returns shows the difference in fund performance. The asset-weighted return for large-cap equity funds was 51 bps higher than the equal-weighted return over the 10-year period. In contrast, the margin between asset- and equal- weighted returns for ELSS funds was only 40 bps. (Asset weighted returns factors in the AUM size of the schemes whereas equal-weighted returns is the arithmetic mean of the returns of the schemes). Over the three-year period ending in June 2018, the asset-weighted return of large-cap funds was 1.3% lower than their benchmark, the S&P BSE 100. During the same period, the asset-weighted return of Indian Equity Mid-/Small-Cap funds was 3.1% lower than their benchmark, the S&P BSE 400 Mid Small Cap Index.

Regulatory Rigmarole

In a recent letter to all public sector banks (PSBs), the Department of Financial Services, Ministry of Finance has asked these banks not to incentivise their employees with commission for cross selling of financial products such as insurance and mutual fund products. In fact, the ministry said that there is no need to incentivise the employees as they work for a fixed salary. Any income accrued of third party product sales is the income of banks. A few years back, Central Vigilance Commission (CVC) had recommended the finance ministry that PSBs should stop the practice of incentivizing their employees with cash benefits. The commission for the cross selling is received by the bank and booked as an Income. The bank in turn runs reward and recognition programme for its employees. The parameters for such schemes involve performance in bank’s core business and cross sell.

The GST council is likely to defer the implementation of reverse charge mechanism (RCM) until March, 2019. Distributors earning less than Rs.20 lakh a year are likely to avail RCM benefits until the government issues a notification to withdraw these benefits. The expected deferment will benefit distributors earning less than Rs.20 lakh who do not have GST registration. In case they are earning less than Rs.20 lakh, but have GST registration, they can cancel their GST registration by visiting this link For distributors with GST registration, AMCs continue to follow forward charge mechanism, i.e., AMCs will pay the gross commission to them. These distributors can avail of the benefits of input credit. Earlier in October 2017, the GST council had first introduced RCM to benefit small businesses until March 2018. Later, the Central Board of Indirect Tax and Custom (CBIC) had extended RCM benefits until June 2018 and then September 2018.

In a major setback for online distributors relying on Aadhaar based eKYC to onboard new clients, the Unique Identification Authority of India (UIDAI) has asked KYC registration agencies (KRAs) to immediately stop doing Aadhaar based authentication for eKYC. In fact, the UIDAI has asked KRAs to give them in writing that they have stopped using Aadhaar based authentication for eKYC. Ever since the Supreme Court has come out with its verdict on Aadhaar, there has been lack of clarity among fund houses, R&T agents and distributors on using Aadhaar based eKYC for onboarding new clients. In fact, a few distributors and fund houses continued withAadhaar based eKYC to onboard new clients. With this, new age distributors would be affected the most as they completely rely on Aadhaar based eKYC to onboard a new client. UIDAI has been reportedly exploring ways to help companies relying on Aadhaarbased eKYC to onboard new customers. eKYC may become operational once again. UIDAI is said to have been exploring ways to help companies relying on Aadhaar based eKYC to onboard new customers, which includes fund houses and online distributors. One approach being considered is to use a live picture of customer with time stamp and photo of a government-issued ID card. Customers can upload their live photograph along with the valid ID proof to complete the KYC process.

Following the Supreme Court’s verdict on Aadhaar, AMFI has discontinued online registration and renewal of ARN for mutual fund distributors with immediate effect. This has come after the UIDAI has asked AMFI, R&T agents and KRAs to give them in writing that they have stopped using Aadhaar based authentication. So far, distributors used to furnish Aadhaar number to register and renew their ARN number through online process. AMFI has assured that they will start the online process soon. Currently, even for online renewal of ARN and EUIN, Aadhaar was required for fetching the photograph of the ARN/ EUIN holder from Aadhaar database. However, since Aadhaar based authentication is no longer permissible, AMFI is in the process of modifying the online ARN/ EUIN renewal facility to facilitate uploading of the photograph by the ARN/ EUIN holder (in lieu of fetching the same from Aadhaardatabase). Till then, distributors can continue to register or renew their ARN through physical process. Currently, distributors have to undergo a mandatory six hours of classroom training in order to renew their ARN. To ease the registration renewal process, NISM has already introduced an online CPE training for distributors. Once distributors take this training, NISM issues a certificate. Distributors have to send their certificates to CAMS along with a DD of Rs.1,500 in favour of AMFI as renewal fee. Typically, the entire physical process of ARN renewal takes around two months. Earlier in June 2017, AMFI had introduced an online ARN registration and renewal facility for distributors.

SEBI has banned upfront commission in mutual funds with immediate effect. In fact, the market regulator has directed fund houses to follow all-trail model to compensate their distributors. In line with its earlier proposals, the market regulator has clarified that fund houses will have to pay such commissions from scheme and not from AMC book. In addition, SEBI has asked fund houses not to do upfronting of any trail commission. However, fund houses can do upfronting of trail commission on SIPs subject to fulfilment of the following pre-defined conditions.


  • ·         Upfronting of trail commission is allowed only for first time investor based on Pan
  • ·         Fund houses can pay 1% upfronting on SIP of up to Rs.5000 for a maximum period of 3 years For instance, if a first time investor starts SIP of Rs.5000 for three years, distributors will get close to Rs.1800 as upfronting of trail commission
  • ·         Fund houses can claw back such a commission on a pro-rata basis from distributors if investors discontinue SIP for which the commission is paid
  • ·         SEBI will take appropriate action if it finds irregularity in this practice

SEBI believes that shifting to all trail model can bring transparency in expenses, reduce portfolio churning and reduce mis-selling in mutual funds.

In a bid to increase transparency in mutual funds, SEBI has asked fund houses to disclose investment and advisory fees and other expenses along with the gross commission of distributors with immediate effect. Simply put, the half yearly consolidated account statement (CAS) will now have two more columns for the disclosure of management fees and other expenses along with the gross commission paid to distributors. However, the market regulator has not clarified if such disclosures will be in percentage terms or absolute terms. In a press release SEBI said, “The scheme’s average total expense ratio (in percentage terms) along with  the  break  up  between investment  and  advisory  fees,  commission  paid  to  the distributor and other  expenses  for  the  period  for  each  scheme’s  applicable plan  (regular  or  direct  or  both)  where  the  concerned  investor  has  actually  invested in.” This commission figure includes all direct monetary payments and other payments made in the form of gifts/rewards, trips, event sponsorships etc. by AMCs to distributors. Also, this disclosure comes with a footnote that reads, “The commission in Col 9 above indicates gross commission received by the distributor against the respective investment and does not exclude costs incurred by distributors such as service tax (wherever applicable, as per existing rates), operating costs, etc.”

SEBI has asked fund houses to publish daily performance report of their schemes on AMFI website. In a recent circular, SEBI has asked fund houses to upload their daily scheme performance data on AMFI website. Currently, AMCs update their scheme performance reports on monthly basis on their own website. However, this data is of no use in volatile markets. Having daily performance data will help an investor make a more informed decision. On the flip side, daily tracking may end up scaring jittery investors further during volatile markets. While investors could access daily performance on mutual fund tracking websites, the AMFI website will make scheme comparison easy for investors and assure investors about authenticity of data. SEBI said that CAGR returns of all plans of a scheme and their corresponding (TRI) benchmark will be available on the AMFI portal. The returns will for the 1-year, 3-year, 5-year, 10-year and since inception time periods. In addition, AMCs will also have to upload 7 days, 15 days, 1 month, 3 months and 6 months performance of overnight funds, liquid funds, ultra-short duration funds, low duration funds, and money market funds on the portal. The returns will be calculated based on previous day’s NAV. Other relevant data such as scheme AUM and previous day NAV will be included in the disclosure. To increase the ease of understanding, the data will have filtering options based on scheme-type, plan-type as well as sorting feature based on return period. SEBI has given a month’s time to fund houses to comply with these regulations.

The regulator has clarified that it would make changes to the MF regulations before introducing new TER slabs. The SEBI circular says, “All other decisions of the Board with respect to ‘Review of Total Expense Ratio (TER)  of  Mutual  Fund  Schemes’ as  mentioned  in  the  press  release  dated September  18,  2018  issued  by  SEBI  would be implemented pursuant  to amendment to SEBI (Mutual Funds) Regulations, 1996. Earlier in September, SEBI has announced fresh AUM slabs and given a roadmap to fund houses on how they can make changes to their TER based on asset size of the scheme. While the market regulator has capped TER at 2.25% in equity funds and 2% in other than equity funds, SEBI has followed economies of scale to reduce TER systematically. Similarly, fund houses cannot charge more than 1.25% in close end equity funds and 1% in close end debt funds. SEBI has also asked fund houses to charge a maximum TER of 1% on passive funds such as index funds and ETFs. On fund of funds (FOFs), SEBI has said that FOFs investing in liquid, index and ETFs cannot charge over 1%. On the other hand, FOFs investing primarily in actively managed funds can charge up to 2.25% in equity funds and 2% in other than equity funds.

Most of you must be aware of UTI Mastershare Unit Scheme. It is the first market linked equity scheme, which did not guarantee returns. Earlier, funds like UTI Unit Scheme 64 either offered assured returns or indicated returns. However, it was the industry’s first market linked product but was a close end scheme listed on stock exchanges. In those days, there was no concept of open ended, daily NAV and trail commission. Fund houses used to launch close end funds or interval funds to collect fresh money. However, the course of Indian mutual fund industry has changed with private players. Kothari Pioneer was the first private mutual fund that many believe has laid the foundation stone of the modern mutual fund industry. Be it an open end fund or SIP, this fund house has brought numerous innovations in the industry that we are today proud of. Fund management too came with its unique set of challenges. The prospect of meeting large scale redemption in open end structure was a daunting one. To mitigate these risks, Mutual Funds used to maintain cash levels of 10% then. However, the biggest challenge was doing research on companies. There were no quarterly reports then. They used to wait for annual reports of the companies. A few companies were more generous as they came out with half yearly report. There was no concept of analyst meetings in companies. They used to approach company secretaries with their stock holding proof seeking appointment with the senior management of the companies. Also, they used to attend AGM just to ask questions to management. At that time, it was rare for brokers to share their reports with them. In fact, there was a misconception in many minds about stocks with some equating stock market with gambling. A lot of innovations that we are witnessing today have come from private mutual funds. Private mutual funds were the ones to start the practice of sharing rationale for stock selection and holdings through monthly factsheets. Right from open end funds and daily NAVs to sectoral funds, debt funds or even SIPs, private mutual funds have strengthened the foundation built by the public sector players.