Do banks recommend mutual funds on merit rather than commission?

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A quick glance at available data provides a mixed picture. Some banks share a highly dependent relationship with asset management companies (AMCs) that are either subsidiaries or related entities.

According to SBI Mutual Fund’s annual disclosure for the financial year 2021-22, about 52% of its commission payouts, amounting to 711.76 crore went to its parent bank. According to the Association of Mutual Funds in India (Amfi ), SBI earned 734.69 crore as commission from its subsidiary for FY2021-22.

Around 67.2% of Union Mutual Fund’s commission goes to Union Bank of India (UBI), accounting for 98% of the bank’s total MF commissions in FY 2021-22. A mutual fund distributor is not legally obliged to distribute the commissions of 43 asset management companies in India. Many distributors, including banks, offer a more limited selection.

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According to news reports, this lack of an ‘open architecture’ is what is worrying the market regulator. Some banks disclose on their own websites the AMC-wise commissions that they get. For instance, HDFC Bank lists a universe which has schemes of 35 AMCs, most of the mutual fund industry. For ICICI Bank, the number is 31. Kotak Mahindra Bank has schemes from 21 AMCs but says it also distributes ‘non recommended AMCs’. HSBC India has 16 AMCs, while Bank of India and UBI only list their sister AMCs.

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It is not clear whether these banks only distribute the products of related entities or offer ‘non recommended’ AMCs too. A former executive at an AMC told Mint that he was unable to convince banks to distribute his AMC’s products as he was not able to offer high commissions.

An HDFC Bank spokesperson said that, as a distributor, it has always believed in open architecture under which it is empanelled with almost all AMCs. “We have a standard commission or brokerage structure across all asset management companies, which under the Sebi regulation pay the commission within the TER (total expense ratio) of the fund. There is no differential payout mechanism. Based on the fund AUM, the TER is as per the slab prescribed by Sebi and the same is followed across all AMCs,” the spokesperson said.

Some AMCs have also retained a variable commission structure. This means higher commissions in the initial years and lower in subsequent years of an investment into the fund. This kind of structure incentivizes the distribution to ‘churn’ the portfolio in order to seek higher first year commissions in newer schemes.

Let’s take an example. ICICI Prudential AMC gives out a 1.15% commission on ICICI Prudential Long Term Equity Fund in the first year. This drops to 1.1% in the second year, 0.6% in the third year and 0.5% the fourth year onwards. Kotak Mahindra AMC offers 1.45% on Kotak Multicap for the first three years and then 1% from the fourth year.

In 2018, Sebi abolished upfront commissions to prevent distributors from unnecessarily churning MF portfolios to get higher commissions. As part of upfront commissions, AMCs give large commissions in the first year and this drops steeply in subsequent years. However, a variable trail commission can frustrate this abolition of upfront commission.

“We provide different incentive structures for our distributors. Some prefer higher upfront and lower trail. Some prefer lower upfront and higher trail, while some prefer consistent payout. We accommodate different payouts within our structure. The gap between first year and subsequent year payout is narrow so that there isn’t much incentive for churn,” said Nilesh Shah, group president and MD, Kotak Mahindra AMC. On commission paid to the sister bank, Shah said, “Even though it is a 100% subsidiary of Kotak Mahindra Bank, we treat it as any other distributor. They treat us like any other MF. Our terms of business are same for Kotak Bank vs comparable distributors”.

According to Kotak Mahindra AMC, in customer folios, unique customers, AUM and sales flow, only low single-digit contribution comes from one distributor. “Our largest distributor is a third-party entity,“ it said.

DP Singh, deputy managing director and chief business officer, SBI MF, said, “Our commission structures are strictly as per Amfi guidelines. Moreover, we have to give an undertaking every month that brokerage paid to the parent company are not more than the brokerage paid to other distributors.” On concentration of AUM coming from a single distributor who happens to be an associated bank, Singh said, “A bank offers a much wider reach across the country and a higher concentration of AUM means greater penetration of MFs. And this AUM is much more stable for the MF industry. As awareness levels for mutual funds increases, there will be a natural pull from bank customers. Though optically, it looks like concentration, money is much widespread and being mobilised from more than 90% pin codes.”

These commission figures are bad from a consumer point of view, but to figure out whether these relationships are causing harm, a third question has to be answered. Are bank-owned AMCs doing a bad job? Data does not provide a clear picture, with some bank affiliated AMCs managing top performing schemes while others rank much lower.

Kirtan Shah, founder and CEO, Credence Wealth Advisors, says, “From an impact standpoint, it defeats the client’s diversification requirement. As an advisor, when I’m trying to mitigate AMC risk in my portfolio, I would want to provide four or five AMC schemes along with two or three styles of investing. But as an individual, if I go to a particular bank and I’m asked to invest everything in that same AMC scheme, then it is risky. By investing everything in one particular AMC, my portfolio would be focused on only one strategy.” The cosy relationships between banks and AMCs are a problem for investors from a choice and competition perspective, something the regulator should take note of.

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