Time to connect the new dots

Shyamal Banerjee/Mint
Live Mint :Arindam Ghosh :4 Mar 2013


New rules of engagement are transforming the way business is going to be done going forward.

The global funds industry, post the global financial crisis, has been treading with trepidation on a landscape where regulation is causing indelible changes. Driven by the singular need to protect investors’ interest, the spate of regulatory changes across the world have been radical and relentless. 

Almost all facets of business and its practices have come under intense scrutiny shaking up the very foundation on which they were built. New rules of engagement are transforming the way business is going to be done going forward. As the ramifications of the accompanying challenges play out, the participants need to quickly rediscover their business model, identify fresh opportunities and combat new threats.

In India the recent wave of reforms should augur well for fund managers and fund advisers alike, though the process of transition can be agonizingly painful and frustratingly slow. For asset managers who have been lobbying very hard over many years for a sympathetic review of the total expense ratio (TER), the recent changes would significantly improve their profitability. 

At a time when demand for greater transparency in TER and lower 12-b-1 fees (advertising and promotion expenses) are gaining momentum across the globe, allowing both fungibility and higher annual recurring expenses is a windfall. The former will allow asset managers the much needed elbow room to manoeuvre their scheme expenses, more significantly trailer commissions and management fees. All at the risk of higher opacity unless additional disclosure standards are prescribed to safeguard investor interest.

 For an industry, which is blamed to be urban–centric, the concern of the regulator to push the frontiers is well justified. Yet, the carrot of allowing asset managers to charge higher expenses for penetrating rural markets may be somewhat baffling. Asking investors in larger cities to pay for client acquisition cost in smaller cities raises fundamental questions.

 Irrespective of that, fund houses who have invested in creating infrastructure and resources will now feel economically motivated and energized to tap into the enormous potential that exists in the smaller towns. World over, scheme recurring expenses have been driven down by economies of scale. In India, scale continues to remain elusive with household participation in mutual funds being abysmally low. 

Over time, as competition further intensifies TER, like in advanced markets, would evolve as a key fund selection parameter and with it the demand and scope for reduction. In the interim, the ball lies in the asset manager’s court.

Globally across major fund markets, regulatory changes are overhauling the distribution models and re-shaping their dynamics. In UK, the Financial Services Authority has rolled out the retail distribution review (RDR) as a key consumer protection strategy compelling distributors to take fees from clients and not the product manufacturers. 

Some countries in Europe as well as Australia are also planning to hurriedly replicate the RDR. The rationale driving such changes are conceived on the back of the argument that commission influence brokers to sell products that are not in line with the interests of their customers and that by eliminating them, investors will eventually start paying for financial advice.

 In India as well, the recently introduced new set of regulations for investment advisers is guided by similar logic and would probably go down in history for pioneering this game changer for the rest of the world to emulate. In an industry, which is so tightly regulated, the process of intermediation was the critical missing link.

 Regulatory oversight of fund intermediaries would help bring order, establish credibility, improve quality of advice and service and achieve consistencies in best practices. Unlike the UK and Australia, the Indian regulator has justifiably taken a more pragmatic view, discriminating the distributors from advisers and the methods of earning their fees. Despite that, while the larger and established fund markets will be able to better cope, the less matured markets such as India may find the process of adjustment somewhat unsettling in the short term.

The recently introduced direct plan with a lower expense structure is in some aspects a clone of the internationally popular I-class without the investment limits. They may appeal to self-serving, well-informed investors who have time at their disposal. However in a country with one of the lowest financial literacy ratios, the risk of taking wrong investment decisions can be very high. 

The onus lies squarely on the asset managers to take investor education right down to the grass root level. The direct plan would also suit the new breed of investment advisers who would increasingly have a bigger role to influence investor-buying behaviour. They would have a lower cost product with an implicit performance advantage on a platter.

As the fund industry prepares to reboot, in a vastly different landscape, the asset managers and fund advisers have to connect the new dots. For them the worst is probably over but most importantly they have the tailwind of good regulations on their side.

Arindam Ghosh is the managing director and CEO of BlackRidge Capital Advisors.