RGESS takes commissions to record highs

Asset management companies (AMCs) are back to paying dizzyingly high commissions to mutual fund (MF) distributors. Fund houses are paying as much as 6% commission to distributors for selling the newly launched Rajiv Gandhi Equity Saving Scheme (RGESS), prompting one asset manager to describe the situation as a “mad rat race” for customers. As a result, a scheme aimed at encouraging access to equities for newbies could end up hurting them. Large commissions in the not-too-distant past led to widespread mis-selling by segments of the financial industry. And this time, the bulk of the target customers are seen to be outside the larger cities, areas where investor understanding isn’t likely to be any higher. AMCs paying such commissions say they have no option but to do so, and that it’s unfair to regard the payout as excessive. DSP BlackRock Investment Managers Pvt. Ltd has promised 6% commission to a few of its distributors. HDFC Asset Management Co. Ltd has promised about 5.5% to a few of its agents. Mint has reviewed emails sent by the fund houses to some of its distributors, citing the commission structure for RGESS. Some fund managers are appalled. “I have never heard of fund houses paying such high levels of commissions, ever,” said Deepak Chatterjee, managing director of SBI Funds Management Pvt. Ltd. Nilesh Sathe, chief executive officer (CEO) of LIC Nomura Mutual Fund Asset Management Co. Ltd, said, “The commissions paid by some fund houses are indeed very high. It is a mad rat race.” RGESS is a tax-savings instrument that was announced in budget 2012 and formally launched by finance minister P. Chidambaram on 9 February. Five fund houses—DSP BlackRock, IDBI Asset Management Ltd, LIC Nomura, SBI Funds and UTI Asset Management Co. Ltd—launched their RGESS MF schemes that day. More are set to be unveiled. In order to entice the first-time equity investor to invest in the stock market, RGESS provides a tax deduction benefit if the person’s gross total income is less than or equal to Rs.10 lakh and has never invested in shares before through a demat account (or in derivatives). Investors can put up to Rs.50,000 in an RGESS scheme and claim a deduction of 50% on the amount. For instance, on a maximum Rs.50,000, investors can avail a deduction of Rs.25,000 (50% of Rs.50,000). Buoyed by high commissions, some distributors have started to aggressively push RGESS. “Since the scheme has a very narrow definition of who a ‘first-time investor’ is, it’s difficult to find such investors in larger cities,” said Mumbai-based distributor Shashank Joshi. “And if we find him, it’s difficult to convince him to invest in RGESS, given that his income is also below Rs.10 lakh.” Joshi also said that distributors need to be compensated for the added effort of assisting the person to open a demat account. The terms of the scheme mean that a large proportion of customers is likely to be found outside the big cities, which is where the MF business is concentrated. “Typically, there is a large concentration of people who earn less than Rs.10 lakh income annually as you go beyond the larger towns,” said Ajit Menon, head of sales at DSP BlackRock. “Also, in the current avatar, RGESS is a tough product to sell, especially when sold in the tax-savings season which we are currently in; the agent also has high-commission products like insurance schemes that vie for investors’ mind space.” Menon said DSP BlackRock wanted to try and “reach out to as many agents in as many locations as possible”. He also pointed out that equity funds are mandated by law to collect at least Rs.10 crore in the new fund offer (NFO) period, or the scheme had to be shut down and the money returned to investors. To be sure, the burden of paying commissions has shifted largely to AMCs from investors as was the case earlier. In 2009, the capital market regulator abolished entry loads (charges of up to 2.25% that MFs used to collect upfront at investment opening that was eventually passed on to the distributor as commission). Since then, fund houses have been paying upfront commissions largely out of their own pockets and from exit-load collections. But last year, the Securities and Exchange Board of India (Sebi) mandated that AMCs need to plough exit-load collections back into their MF schemes. To compensate for this, it allowed fund houses to charge an extra 20 basis points (bps) from investors, as part of the scheme’s total expense ratio (TER). A basis point is 0.01%. This latest change was part of a plan Sebi unveiled last year permitting fund houses to charge about 50 bps of additional TER to, among other things, increase penetration to areas “beyond the top 15 cities”, also referred to as B15. After Sebi’s move, first-year payouts (upfront charges and first-year trail fees) have gone up by 25-35 bps across equity and long-term bond funds to about 1.75% of the investment amount garnered. Most fund houses have also increased commissions for their equity-linked saving schemes to up to 4.5-5%, up from about 3.5% that they used to pay earlier. B15 charges for the first year have gone up to 3-3.5%. RGESS tops all those structures with commissions that have touched a record high payout by fund houses. Nearly the entire commission on RGESS is paid to the distributor upfront when the money comes in, since investments under the scheme are locked in for three years. Milind Barve, CEO of HDFC Asset Management, contended that the RGESS commission “looks high, but really isn’t. The commission is paid upfront and therefore the figure looks high. It is the usual practice”. The commission figures reviewed by Mint aren’t the same for all agents. A fund house has different commission structures for its various distributors. Though investors don’t pay these commissions over and above what TER mandates (up to 3% of the scheme’s weekly average net assets, every year), fund officials say such high payouts are unhealthy for AMCs. According to the rules, AMCs can amortize, or spread, the high commission costs (the portion that they have absorbed in their own books) over the tenure of the scheme if it’s a closed-end one and, thus, distribute the hit they take in year one. That’s why not everybody’s convinced about the justification for high commissions. “The Indian AMC industry’s business model does not permit us to pay such high commissions,” said Sathe of LIC Nomura. “If one or (a) few AMCs start paying high commissions, the pressure comes on other AMCs to follow suit. Small fund houses are bleeding and the industry is in dire straits.” Chatterjee of SBI Funds allowed that “agents need to be compensated because they work to get inflows”, but said that “commissions need to be paid that the MF business model can legitimately support. Sebi’s stance, over recent years, has been to get away from paying hefty commissions, but what is happening is quite the opposite”. What makes the commissions particularly worrisome is that the scheme is meant for the first-time equity investor. Hefty commissions also leads to mis-selling at times, experts say. Before entry loads were abolished, collections from NFOs used to be 35-45% of the overall collections in equities, according to a Mint analysis that was part of a story published in 2012. After entry loads were abolished, the number of NFOs dropped drastically, to 3-7% between 2008-09 and 2011-12. “RGESS is not just open for those who wish to save tax. Even those investors who do not need to save tax, like the ones who fall in the 30% tax bracket and don’t meet the eligibility criteria, can invest. Ultimately, over-enthusiastic distributors might end up selling RGESS to them, without these investors really coming to know where their money is invested,” said Joshi, the distributor. What’s more: money invested in a closed-end RGESS MF scheme is locked in for three years, irrespective of whether an investor opts for the tax benefits or not. After three years, the money gets redeemed automatically, again, irrespective of whether an investor opts for the tax benefit or not. No wonder then that commissions have hit the roof.