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The Joke is no longer on you

There's a fundamental change afoot in the way mutual funds are sold in India

A few days back, when SEBI banned upfront commissions being paid for mutual fund investments, I had written that this was a very big deal and that it would align the incentives of the investor and the salesperson in a fundamental way. Many knowledgeable investors were sceptical, no doubt out of bitter experience. However, when one looks at the actual past examples of bad advice and anti-investor behaviour by salespersons, then one can see what will change.

Here's a really interesting recent example that has stuck in my head. Some months back, I came across the case of an anti-SIP mutual fund salesperson. An acquaintance said that he had just made an investment of a few lakh rupees in an equity mutual fund. When I asked how many months he had done the SIP for, he said that he hadn't made the investment through a SIP. Apparently, the salesperson, who was from this big private bank where my friend had an account, advised him against it. The salesperson said that SIP were only meant for situations when the market was going to perform badly. When it was going to do well, then SIPs are harmful.

It is correct that when if you start an SIP and the markets do well, then you make somewhat lower returns than you would otherwise have done. It is also correct that when the markets are doing badly, it is extra beneficial to be investing through an SIP. However, I'm sure you have spotted the problem--everything depends on whether you (or rather, the salesman from the bank) can predict the future correctly.

At this point, you should take a break from reading this article and watch this brilliant stand-up comedy piece by Sumit Anand.

Getting back to our example, the entire advice depends critically on the bank guy knowing how the market is going to do, which is actually a fitting subject for stand-up comedy. The real story here is that if that customer had started an SIP, then the bank and the salesman would have gotten a commission in small monthly doses, as the investments happened. However, if a big amount was invested in one go, then they get a big commission at once. That is all. That, in its entirety, was the reason that people like that were downselling SIPs. This nonsense was facilitated by the fact that the markets were doing exceedingly well at that point. Therefore, it was an easy story to sell.

However, this entire incentive structure stands reversed now. Under the new rules, a lump sum investment would not get the salesperson any upfront commission. Instead, it would get him a small monthly commission as long as the investment stayed in place. In contrast, an SIP investment would get him three years' monthly commission in advance. Moreover, if the SIP was stopped during the three years, that commission would be clawed back. So in the above case, the most profitable path for the bank and the salesperson would be to recommend an SIP in a good fund so that the investor would continue for as long a period as possible.

Which is exactly what would be best for the investor as well. This alignment of interests is something that has never happened before in any retail financial product in India. Therefore, I think it's time to be cautiously optimistic about what Indian savers are going to do with their mutual fund investments.

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