Financial planners and mutual funds are advising clients to invest in stock markets with a long-term view. But, a report by one of the leading mutual fund registrars shows that there is no such thing as long-term.
According to the Churning Report, 12 per cent of all equity and balanced fund purchases brokered by the top 20 distributors during 2004-05 were encashed and redeemed within a month.
About 30 per cent were redeemed within three months and nearly 50 per cent within a year.
The top churners during the year were big banks apart from several institutional brokers and distributors.
Among the top 20 distributors on the basis of sales, the top churner has been IDBI Capital Market services, which collected Rs 376 crore (Rs 3.76 billion) during the financial year while clocking redemptions worth Rs 357 crore (Rs 3.57 billion).
Two distributors -- IDBI Capital Markets and ABN Amro bank NV -- saw over 20 per cent of their allocations (fresh purchases and switches) redeemed within 30 days of entry into the fund scheme.
Similarly, six distributors -- IDBI Capital market Services, ABN Amro Bank, Standard Chartered Bank, SBI Capital Markets, NJ India Invest and IDBI Bank -- churned their total equity allocations over 35 per cent within three months from the date of entry.
Nearly half of the top 20 distributors churned their allocations over 50 per cent within one year. For the record, banks have emerged as the largest distributors of mutual funds in the country. Nearly, 60-70 per cent of retail collections come from banks. Of this, foreign banks contribute a significant portion.
The huge churn in mutual funds has been a consequence of a plethora of new fund launches. Distributors normally get double the amount as commissions on sale of new fund offerings.
While commission for new fund offerings are about 4 per cent, the same on existing funds is only around 2 per cent. Due to the differential commissions, distributors prompt clients to switch funds more often than required. This often results in sub-optimal returns for investors.
Meanwhile, the Securities and Exchange Board of India is miffed with the widespread mis-selling in mutual funds.
The regulator has directed the Association of Mutual Funds of India to come out with an alternative expense structure for new fund offering that will ensure that distributors do not unfairly oversell new fund offerings to clients, hurting investors in the process.
'We have asked AMFI to suggest an optimal fee/commission structure for new fund offerings, failing which, we will prescribe an alternative to curb churning.' While some amount of churning is fine from the perspective of profit booking, the alarming rate of churning, especially, in equity funds is disturbing, said a top Sebi official.
Separately, there is also a need to look at the kind of forms/agreements investors signs up with their advisors to see whether such fund switching decision are done with the due knowledge and permission of the clients.
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