The Securities Exchange Board of India (SEBI) must think twice before giving in to pleas from the mutual fund industry on charging part of its distribution costs to direct plans. If implemented, the move could result in distribution commissions being loaded on to investors who have consciously chosen not to use services of distributors in selecting their mutual funds. Allowing this will also introduce an element of opacity and discretion on the charging of costs to direct plans, which runs counter to SEBI’s ongoing effort to make Total Expense Ratio (TERs) more easily enforceable and transparent.

It was in 2013 that SEBI required all mutual fund schemes to offer a direct plan to investors, which would exclude all distribution commission and costs charged to the regular plan. This proved a game-changer for both investors and the industry. Since then, investors in direct plans have saved 50 to 150 basis points a year across fund categories, earning higher returns. The direct plan has also been the catalyst to the emergence of user-friendly online platforms that have made mutual fund investing a friction-free exercise, drawing hordes of young investors. The growth of a fee-only registered investment advisor ecosystem, which provides conflict-free advice to investors, is also predicated on direct plans remaining commission-free. In fact, the success of direct plans in mutual funds has prompted SEBI to explore the same model for Portfolio Management Services and Alternative Investment Funds as well.

The arguments put forth by the industry in favour of charging part of the distribution commission to direct plans seem weak. The first is that regular plans cross-subsidise direct plans because the marketing and distribution costs that AMCs incur on promoting their funds are borne mainly by regular plans. As nothing in the SEBI regulation prevents AMCs from charging actual marketing and promotion costs to direct plans (only distribution commission cannot be charged) and direct plans are seldom marketed or promoted separately, it is difficult to see where this cross-subsidy arises. If the issue arises due to inaccurate estimation of costs across different heads, it should be sorted out through better estimation and allocation practices.

As to the claim that mutual funds require active distribution, 46 per cent of the aggregate assets and 24 per cent of the individual assets managed by mutual funds are already attributable to the direct route — they have clearly come in without a distribution push. If these demands are cropping up now because the mutual fund industry is not confident of keeping to the lower TER limits currently being deliberated by SEBI, this can be addressed by allowing AMCs to foot the bill for expenses exceeding regulatory limits (out of their own P&L). Direct investors should not be burdened.

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