Questions to ask your mutual fund distributor:

Mutual fund distributors are intermediaries between investors and mutual fund (MF) houses. They earn a commission from the fund house for selling MF schemes to retail investors.

Mutual fund distributors must understand investors’ financial requirements to suggest the most suitable schemes. Investors must also ask the right questions to determine whether the distributor has higher standards of knowledge, attitude, and ethics.

Who is an MFD, and how do you find one?

MFDs (Mutual Fund Distributors) are intermediaries certified by AMFI (Association of Mutual Funds in India) to guide investors with investments in Mutual Funds. They are certified by the Association of Mutual Fund Industry (AMFI) and regulated by the capital markets regulator – SEBI. Individual MFDs have existed in the MF industry since the 1990s and collectively manage investments of over ~Rs. 13,00,000 crore. There are 2 lakh+ MFDs in India as of now, and you can use the following link to locate MFDs in your vicinity – AMFI Locator 

When you invest through a distributor, your investments are under a regular plan. For starters, the investments are under a direct plan for those who invest in mutual funds without intermediaries. 

 

What qualities must a retail investor look for in an MFD?

Understanding an MFD’s processes and knowledge levels to build trust is important.

This involves inquiring about the overall process approach that the MFD uses. 

A mechanism to evaluate the investor’s risk profile 

• There are over 2500 Mutual Fund schemes with a varying level of risk and return profiles. A very high-risk investment category, such as Small Cap or Sectoral Funds, can yield higher returns but has historically shown 30-40% negative returns in a single year. These investments are more suitable for investors who can stomach such volatility. Meanwhile, a low-risk fund, such as an overnight/liquid fund, can deliver steady returns even when volatile equity markets occur during a particular year. Such funds suit investors looking for stable growth and less volatility. 
• Given the large number of fund categories, each with pros and cons, measuring and understanding an investor’s risk profile is essential before recommending suitable schemes.

Process to understand the primary financial goals of the investors

• Understanding the investor’s financial goals provides a guideline for estimating the risk capability and time horizon of the investment. Typically, investors could take on higher risk, invest in equity-oriented schemes for long-term goals (5+ years), and stick to debt-oriented schemes for a shorter duration.

The process to shortlist and recommend good quality MF schemes, and what are the critical parameters they use to select the schemes

• Given the vast universe of funds, it is essential to understand how the MFD is narrowing it down to a particular set of schemes they recommend. Asking this question provides confidence to the investor in the MFD’s knowledge and expertise, which is paramount to building trust.

Periodic portfolio review mechanism

• Making your first Mutual Fund investment is a small part of your investment journey. Equally important, if not more, is monitoring and reviewing investments regularly. It is advisable to review the portfolio every 6 months or so. The funds invested might have underperformed w.r.t peers and benchmarks (or) the debt/equity asset allocation might have to be rebalanced as per the investor’s goals and risk profile. Understanding the mechanism the MFD follows to review the portfolio will demonstrate his capabilities in recommending funds and guiding you until you reach your financial goals.

Most experienced MFDs are also registered with the Insurance regulator (IRDA) to guide you with health insurance & term insurance, which play a crucial role in financial planning. Working with an MFD who can help you with all financial products is preferable, as they can be the single point of contact for you & your family. Additionally, it is advisable to speak to a couple of existing clients of the MFD. This can further help build your confidence before trusting them with your investments.

 

How do mutual fund distributors earn money?

 MFDs receive commissions directly from the mutual fund houses. 

A typical MFD will earn a trail fee of 0.5 – 1% per annum. For example, for a client with a portfolio of Rs 10 lakh, an MFD can earn between Rs. 5,000 – Rs. 10,000 per year, paid in instalments monthly. This trail fee is built into the Regular plan Mutual Fund expense ratio that the MFDs recommend and is paid out to them as a commission by the AMCs. Investors need not (and should not!) pay a separate fee to the MFDs.

 

If distributors earn commission from mutual fund houses, would there be any conflict of interest?

Concerns and stories about conflicts of interest regarding the fees earned could exist, but regulatory changes in the past decade have largely aligned the interests of the MFDs with those of the clients.

However, it is equally essential for the investor to be on top of their finances and ask the right questions. So make sure you select the right MFD! 

Some of the red flags that could potentially indicate the MFD is not working in the best interest of the investor – 

1. I recommend NFOs that do not have a performance track record, especially when the fund category has good-performing funds with a better vintage.
2. Frequent churning of the portfolio refers to the MFD asking investors to redeem and reinvest in different funds frequently. This increases the transaction/tax costs for the investors, thereby decreasing the portfolio return.
3. Offering guaranteed returns. Mutual Funds as a product do not offer guaranteed returns, and as per the regulations, MFDs are not allowed to promise a guarantee of returns for any scheme/fund category.

The commission structure for MFDs has evolved considerably over the past two decades, owing to the regulator’s focus on transparency and client-centricity.

 

What questions must one ask in the periodical reviews of MFDs?

 A periodical review ensures that the investments are on the right track. Any MF portfolio needs to be reviewed regularly – usually every six months or so. The investor needs to ask the following questions during the portfolio review.

 Are my Mutual Funds performing well and generating returns as expected?

• A simple way to check for underperformance is to compare the fund returns with those of the benchmark over a period of time. A benchmark is a standard against which fund performance can be measured and is defined by the AMC for every fund. Although funds might have short periods of underperformance, consistent underperformance (over three years) means that you should revisit the investment.

Is there a need to rebalance my portfolio/asset allocation?

• As investors approach their financial goals, their allocation to equity-oriented funds should gradually reduce and move towards more stable debt-oriented funds. 

Do the investments cover all of my financial goals?

• In today’s fast-paced world, investors’ financial goals can evolve. Whether they’re making an unplanned car purchase or a sudden decision to purchase a home when they retire, investors should ensure that all their financial goals are accounted for and planned for.

If there is an investible surplus, how should it be invested?

• Investing a fixed amount regularly is a great way to inculcate the discipline of regular investment. Still, in many cases, an individual can accumulate an unplanned surplus over time. The investor can discuss this with their MFD to understand how the surplus can be invested.