July 14, 2017

Of Commissions and Biases

At the end of each financial year, AMFI discloses on its website, the commissions paid across fund houses to key mutual fund distributors.  Looked at, in the right way, this information can give investors, as well as industry insiders, a lot to think about.  It can also be a source of trivia and gossip.  This year, for instance, thanks to a write-up in at least one newspaper, and reports on other financial portals, there was some buzz on social media about the rising number of “crorepati mutual fund distributors”.  I am not an expert on these matters but I can’t help feeling that the so-called journalists and reporters would have had a much more news-cum-gossip-worthy story on their hands if they had chosen instead to report on the presence of Reliance Gas Transportation Infrastructure Limited in the august list of top mutual fund distributors.  I suspect that it would have been most interesting for their readers to know why a company that is engaged in the business of construction and operation of pipelines for the transportation of natural gas, also acts as a mutual fund distributor, and was ranked among the top 50 in terms of Gross Inflows in 2016-17, and among the top 100 in terms of average AUM and commissions received.  I have my own theories about this but I’ll park those for another day, and instead get straight to the purpose of this post i.e. to spotlight a few of my more substantive observations in AMFI’s latest Distributor Commissions report.

Seen in conjunction with what individual fund houses report, AMFI’s report can be particularly useful as a starting point to understand how unbiased the advice of a distributor might be.  While prudence would suggest that a distributor should not over-expose clients to a single fund house, having a bias towards one particular fund house, in itself is not dubious.  It depends on the motives for the bias, the extent of the bias and which is the fund house towards which the distributor is biased. 

Take State Bank of India, for instance.  In 2016-17, it ranked second among fund distributors in terms of net inflows, and seventh in terms of commission received.  It is, by far, the most prominent PSU bank distributor of mutual funds.  Yet the fact is that 99% of its commission came from SBI MF.  This would seem to indicate that the mutual fund distribution activities of State Bank of India exist only to promote SBI MF.  Put differently, it would appear to be foolish to walk into a branch of State Bank of India and expect to get unbiased advice across multiple fund houses.  But then, while State Bank of India may be entitled to adopt a strategy to only promote SBI MF, it raises a rather troubling question (in my mind, at least): if the mutual fund distribution division of State Bank of India is, in effect, an extended arm of SBI MF, then how fair is it to their clients, to offer regular plans, instead of direct plans?

The State Bank of India model is one that most, if not all, PSU bank distributors, that have their own fund houses, have sought to follow.  But what of the top private-sector bank distributors such as ICICI Bank, HDFC Bank and Axis Bank? 

In my conversations with people at these banks, I get the impression that they like to proudly position themselves as multi-fund house distributors.  In the process, I have heard terms such as “unbiased advice” and “one stop shop for all mutual funds” being thrown around.  And as proof of the diversity in fund houses and schemes offered, some shared with me copies of the monthly fund recommendations that they send to their clients.  Yet when I look at the Distributor Commissions reports, a different picture seems to emerge.  Consider the following, all relating to the year 2016-17:

  • HDFC Bank, which had the highest average AUM among all distributors, received 44% of its commission from HDFC MF
  • Axis Bank, which had the second highest average AUM among all distributors, received 61% of its commission from Axis MF
  • ICICI Bank, which had the fourth highest average AUM among all distributors, received 69% of its commission from ICICI Prudential MF

Based on these numbers, the claims to offer “unbiased advice” would appear to be hogwash.  It would seem that these banks are not vastly different from SBI or other PSU Banks in promoting the interest of the fund houses that they have sponsored, or are associated with.  And hence, here, too I find myself questioning the fairness of these banks towards their clients in offering them regular plans instead of direct plans.

While the above named banks are among the leaders of the mutual fund distribution community they are, by no means, the only ones exhibiting such significant biases.  Also, the element of bias is not restricted only to firms that have promoted fund houses.  One of the more startling examples that caught my attention relates to a distribution firm that is not associated with any fund house.  It calls itself a “wealth management boutique”, and ranks among the top 100 distributors in terms of average AUM during 2016-17 and among the top 70 distributors in terms of commissions earned.  But more than any of that, I was struck by the fact that in 2016-17, it received 70% of its commissions from a single fund house: JM Financial MF (JM MF).  Not only that, it appeared that this firm was way more biased towards JM MF than even its own associate distribution firm, JM Financial Services.

When I shared my observations with one of my frequent collaborators, he asked me this question: “How widespread are these biases?” 

He happens to be  registered with SEBI as an investment advisor (RIA), and the way he asked the question, it seemed as if he wanted to see if my findings could help make a stronger case for RIAs.  At first, I tried to dissuade him from pursuing that line of thought but when he insisted, I decided to humor him.  In his way of seeing things, the receipt of at least 40% of one’s commissions from a single fund house was the key indicator of a questionable bias (there were a couple of other criteria as well, too lengthy to describe here). So, following those criteria, (and based on the data of the 687 distributors covered in the 2016-17 report) I put before him my findings in a nutshell:

  • 32% of the key distributors appear to have a questionable bias
  • These distributors were credited with a combined average AUM of 227,395 crore in 2016-17

He seemed to like my findings because I saw a smile light up on his face.  But then I said something else and his smile vanished completely.

“By the way,” I said, “that wealth management boutique that I mentioned earlier… the one which earned 70% of its commission from JM MF… well, that firm also happens to be a RIA.”

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