Should you worry about MF commissions?

Tue, 7 Oct Pre-Open

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Even though a few years have passed, we still remember the days of high Mutual Fund commissions. It was a common practice before SEBI banned the practice of upfront commissions being charged directly to the scheme in 2009. Agents would only sell those schemes that provided the highest payoffs. Factors like past returns and the risk profile of the fund were ignored. Retail investors were sold mutual funds by agents promising dubious returns. The result was for all to see.

As long as the markets were rising, investors did not mind as they too were making profits. However, when the tide turned investors ended up getting sub-par returns. Thus, for the last 5 years, the MF industry has been witnessing a steady out flow of funds. Now, the tide seems to be turning yet again. The markets have revived over the last one year. Asset Management Companies (AMCs) are on the look-out for fresh funds. Yet, as the old saying goes, 'the more things change, the more they stay the same'! AMCs are using the bait of high commissions once again. The latest trend is the closed-ended fund.

In closed-ended funds, investors cannot withdraw their money until the end of the lock-in period (usually three years). This allows the AMCs to pay their agents the full commission upfront for three years. In many cases, the commission is as high as 4.5%. Banks earn even more as they bring in a large amount of funds compared to individual agents. If an article in Livemint is anything to go by, the recent spate of closed ended funds have garnered Rs 43 bn this year alone. This could be dangerous for investor's health. The lock-in period for these funds will only end in 2017. Will we still be in a bull market then? That is anyone's guess. It must be pointed out that many people who invested in such funds in 2005-06 were staring at losses in 2008-09 when the lock-in period ended.

Does that mean you should not invest in them? Not necessarily but we should certainly view any issue with caution. These funds will provide similar returns compared to open-ended funds. The lock-in will only encourage MFs to distribute higher upfront commissions. This provides a big incentive to agents to push these funds. If you are being approached by a MF agent with a sales pitch for closed-ended funds, do not be swayed. More often than not it is their commission and not the client's financial well being that is on top of their mind.