Do banks recommend mutual funds on merit rather than commission?

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

According to the annual publication of SBI Mutual Fund for the financial year 2021-22, approximately 52% of its commission payments, i.e. 711.76 crores went to its parent bank. According to the Association of Mutual Funds in India (Amfi), SBI won 734.69 crore commission from its subsidiary for the 2021-22 financial year.

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

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According to dispatches, it is this lack of “open architecture” that worries the market regulator. Some banks disclose on their own websites the AMC commissions they receive. For example, HDFC Bank lists a universe that includes patterns from 35 AMCs, most from the mutual fund industry. For ICICI Bank, the number is 31. Kotak Mahindra Bank has 21 AMC programs 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 unclear whether these banks only distribute the products of related entities or also offer “non-recommended” AMCs. A former AMC executive told Mint that he was unable to convince banks to distribute his AMC’s products because he was unable to offer high commissions.

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

Some AMCs have also retained a variable commission structure. This means higher commissions in the first years and lower in the following years of an investment in the fund. This type of structure incentivizes the distribution to “churn” the portfolio in order to obtain higher first-year commissions in newer programs.

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

In 2018, Sebi removed upfront commissions to prevent distributors from unnecessarily shuffling MF wallets for higher commissions. As part of the initial commissions, CMAs give large commissions in the first year and this drops sharply in subsequent years. However, a variable trail commission can counteract this abolition of the initial commission.

“We offer different incentive structures to our distributors. Some prefer a higher and lower track. Some prefer a lower lead and a higher lead, while others prefer a consistent payout. We accommodate different payments within our structure. The gap between the payment for the first year and the payment for the following year is narrow, so there is not much incentive for churn,” said Nilesh Shah, Group Chairman and Managing Director of Kotak Mahindra AMC. On the commission paid to the sister bank, Shah said, “Even though it is a 100% subsidiary of Kotak Mahindra Bank, we treat it like any other distributor. They treat us like any other MF. Our terms of business are the same for Kotak Bank as for comparable distributors.”

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

DP Singh, Deputy Managing Director and Chief Commercial Officer of SBI MF, said: “Our commission structures are strictly in line with Amfi guidelines. In addition, we must commit each month that the brokerage fees paid to the parent company will not exceed the brokerage fees paid to other distributors. A bank offers a much wider reach across the country and a higher concentration of AUM means greater MF penetration. And this AUM is much more stable for the MF industry. As mutual fund awareness levels increase, there will be a natural attraction of banking customers. Although optically it looks like concentration, the money is widespread and is mobilized from more than 90% of PINs.”

These commission numbers are bad from a consumer perspective, but determining whether these relationships are causing harm requires answering a third question. Are bank-owned AMCs doing a bad job? The data does not provide a clear picture, with some bank-affiliated CMAs running top-performing programs while others rank much lower.

Kirtan Shah, Founder and CEO of Credence Wealth Advisors, says: “From an impact perspective, this goes against the client’s requirement for diversification. As an advisor, when trying to mitigate AMC risk in my portfolio, I would like to offer four or five AMC programs as well as two or three investment styles. But as an individual, if I go to a particular bank and they ask me to invest everything in that same AMC program, then it’s risky. By investing everything in a particular AMC, my portfolio would be concentrated in a single strategy.” The warm relationship between banks and AMCs is a problem for investors from the point of view of choice and competition, which the regulator should take note.

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Aurora J. William