How Mutual Fund Distribution Works, Step by Step

Mutual fund distribution is the route a scheme travels to reach a person. A distributor holds a registration, the asset manager empanels them, an application carries the distributor code, the money and the application reach the scheme, the registrar and transfer agent allots units into a folio, and from that day the plan's expense ratio accrues daily against the scheme's assets.

Four things this route depends on are settled elsewhere. A distributor is engaged by the asset manager rather than by the person who buys, and is paid out of a component sitting inside the scheme's expense ratio. Which day's value per unit an application receives turns on when the application and the money reach the scheme. The registrar and transfer agent keeps the record of who holds what. And one scheme can be offered in two plans carrying different expense ratios over an identical portfolio. A single purchase, followed from the first arrangement to the last accrual, shows what each step hands to the step after it.

One scheme runs through the walk from end to end. Girnar Asset Management Limited, an invented asset manager, operates the Girnar Large Cap Equity Fund, an open ended equity scheme. The fund carries net assets of Rs 4,200 crore against 120.00 crore units outstanding. Dividing the first by the second makes one unit worth Rs 35.00 exactly, and that figure is what the whole walk turns on. The scheme is held across 3,80,000 folios, so the average holding sits at about Rs 1,10,526/-. Kalyani Bhagat runs the portfolio and Sohail Merchant runs operations.

The distribution routeThe fixed order in which a scheme, a person and a set of records are brought together so that a holding can be created and traced back. is not a figure of speech. The route is a fixed order of ten steps, each of which hands something specific to the next, and a step taken out of order does not slow the route down, it stops it. Almost every misunderstanding about distribution turns out to be a misunderstanding about which step does what, so read the order once before reading the reasons. Here is the whole of it in one place.

Why does a scheme need anybody in between at all?

Because a scheme has no legs. Girnar Asset Management Limited could sell the Girnar Large Cap Equity Fund only to whoever finds the manager unaided, walks in and asks for it. Some people do exactly that. Most people never will.

Think about a seed company for a moment. The company can grow the best seed in the state and sell it from one office in one city. Nobody within a day's travel is holding the packet and answering questions about it, so the farmer four districts away still plants something else. The seed is not the problem. The distance is.

Distribution exists because most households do not arrive on their own, and because somebody has to be sitting in a town where the asset manager has no office. That is the entire reason the route exists, and every step that follows does one of three jobs: putting that person in place, letting them be identified afterwards, or paying for the years in which they stay.

What has to be in place before a single rupee moves?

Two things, in a fixed order. First the distributor holds a registration. Then Girnar Asset Management Limited empanels them, and empanelmentThe arrangement between an asset manager and a distributor under which that distributor may carry the manager's schemes and have transactions recorded against them. is the arrangement between the two that lets the schemes be carried and lets a transaction be tied back to whoever brought it.

The order is not a formality: registration first, empanelment second, and only after both is there any point bringing a single rupee. Without an arrangement the manager has no way to accept the application, no way to process it and no way to record who brought it. So a distributor holding a registration but no arrangement with Girnar Asset Management cannot carry the Girnar Large Cap Equity Fund. A distributor with an arrangement but no registration cannot carry anything at all, anywhere.

The registration's own requirements, who grants it, how long it runs and what has to be renewed are all set by the Securities and Exchange Board of India (SEBI), and the industry level framework around it is administered by the Association of Mutual Funds in India (AMFI). The position in force is read at sebi.gov.in and amfiindia.com. A condition of that kind does not merely go out of date the day it changes. It goes wrong, and somebody acting on the old version ends up worse off than somebody who was never handed it.

What is the identification, and what does it let anybody do?

Three identifiers travel with a distribution arrangement. The distributor holds a registration number, the AMFI Registration Number, written ARN. An individual acting for that distributor carries a personal identifier of their own, the Employee Unique Identification Number, written EUIN. The transaction itself carries the distributor codeThe field on an application that names which distributor the transaction is to be recorded against.. The code connects the first two to a particular application on a particular day.

The least intuitive thing on the whole route is what these three identifiers are for, and it is worth sitting with. The identifiers exist so that a transaction made today can still be traced to a particular party many years from now, long after the conversation, the office and possibly the person have all gone. That tracing is what attributionThe recording of which party brought a transaction, kept alongside the holding so the question can still be answered long afterwards. means on this route. Attribution is not a marketing device and not a tracking number for the buyer. Attribution lets a record answer, in the ninth year, who brought the ninth folio.

How the three are issued, what has to be declared when one of them is used, and what happens when one is missing from an application are covered separately, further on. Only the timing matters at this step. An application cannot carry a code that does not yet exist, so the identification is issued before the application is made, never afterwards.

What happens when a household and a distributor actually sit down?

The scheme gets explained. Somebody asks what it holds, what it has done, what happens if the money is needed at short notice, and whether it suits a person who is saving for a daughter's education eleven years from now.

Almost everything a household ends up believing about a scheme is formed in this step, and the conduct rules governing that conversation are set out separately. What may and may not be said when a scheme is explained, what has to be disclosed while saying it, and where the line between carrying a scheme and advising on it actually falls are regulated questions with conditions attached to them, and they are covered separately under wealth and advice.

A conversation happened, a decision came out of it, and everything after that point is paperwork and arithmetic that can be checked.

Where does the route become visible on paper?

On the application. Up to this point the route is an arrangement and a conversation, neither of which anybody can pick up. From here it is a document that somebody can pick up nine years later and read.

Three things have to be in order before the form goes in. The personal identifier and the know your customer (KYC) record must already be complete rather than in progress. The plan has to be selected. And the distributor code has to be written on the application itself. The distributor code is the entire route compressed into one line of a form.

The code attaches the transaction to a distributor and it selects nothing whatsoever about what is being bought. The code does not choose a security. It does not change a weight. It does not touch Kalyani Bhagat, the mandate she runs to, or the method by which the value of one unit is struck. A reader who believes the code changes the product has misread the entire arrangement, and that single misreading is responsible for more bad feeling about distribution than any figure in this walkthrough.

The code changes exactly two things: which plan's expense ratio applies to those units from the day they are created onward, and who is recorded beside the folio. Both are administrative entries. Neither of them is a security.

Which day's value does the application get?

Not the day of the conversation, and not the day the cheque was written. Both of those feel like the answer and neither of them is.

The applicable valueThe value per unit that a particular application is processed at, decided by rules about when the application and the money reached the scheme. per unit turns on when the application and the money reach the scheme, and the rules that decide it are made by SEBI. The rules move. Read the version in force at sebi.gov.in on the day it is needed.

One structural point is enough to remove the mistake that actually costs people something. The price is struck by the scheme, once, for the scheme. The price is not negotiated on the route. It is not quoted by the distributor. It does not arrive in two versions depending on who carried the form. Whatever the applicable value turns out to be on a given day, it is the same number the scheme struck that day for everybody whose application and money arrived on the same footing.

Who writes the holding down, and where does it actually live?

The registrar and transfer agent writes it down. Money becomes units at this step, by a division and nothing else.

On the day of the worked purchase the applicable value per unit is Rs 35.00, struck by the scheme from net assets of Rs 4,200 crore over 120.00 crore units outstanding. Rs 1,00,000/- divided by Rs 35.00 is 2,857.142857 units. The scheme's own stated rounding conventionThe rule a scheme states for how many decimal places a unit balance is carried to when a division does not come out exactly. carries units to three decimals, so the allotmentThe creation of units in a holder's name against an amount received, at the value per unit that applies to that application. is 2,857.143 units. The third decimal rounded upward, so the folio received about 0.000143 units more than the exact division gave it, worth about Rs 0.005/-, half a paisa. Multiply back and the arithmetic closes from the other side: 2,857.143 units at Rs 35.00 is Rs 1,00,000.005/-, and there is the half paisa again.

Then the units are written into a folio and the attribution is recorded beside them on the registerThe record of who holds how many units in a scheme, maintained by the registrar and transfer agent rather than by anybody who sells the scheme..

The holding lives on the register and not with the distributor, and that single fact is why this step exists as a step of its own rather than as a detail of the one before it. If the distributor closes their business tomorrow, retires, moves cities or is replaced, the folio holds exactly what it held the day before. Nothing about the units, the value or the entitlement was ever stored with the person who carried the form. A reader who has understood step seven has already answered half the anxious questions people ask about distribution.

When does the distribution component start being charged?

From allotment. And then every day after that, with no bill and no deduction, for as long as the units exist.

The plan's expense ratio is set against what the scheme holds, one day at a time. Where the plan carries a distribution component, that component runs inside the ratio rather than beside it. The charge is a daily accrualAn amount recognised as owed by the scheme each day and set against its assets before the value of one unit is worked out.. No event exists for a holder to point at, and no moment when anybody is asked for anything.

Rupees are the only honest way to feel the size of it, so put it in rupees on the worked folio. The Girnar Large Cap Equity Fund is offered in two plans over one identical portfolio, at 1.65 per cent and 0.85 per cent, both measured against the scheme's net assets. A holding of Rs 1,00,000/- carries its proportionate share of that charge, so on a holding held steady for a year the two plans work out at Rs 1,650/- and Rs 850/- respectively. The difference between them is Rs 800/- across the year, or about Rs 2.19/- a day. Not one paisa of that Rs 800/- is deducted from the folio, billed to the household or printed on a statement: it comes out of the scheme's assets before the value of a unit is worked out, so it arrives as a value per unit very slightly lower than it would otherwise have been.

How much of that Rs 800/- reaches the distributor, and how much stays with the manager, is fixed privately by the terms between them. The whole route can be described completely without a commission rate.

So what can a holder actually see? Only drift. With both plans set at 100 on the day of allotment and everything else identical, the plan carrying the distribution component reads about 96.09 against 100 after five years, about 92.34 after ten and about 85.27 after twenty. How the gap compounds is set out separately under what a fund costs. The narrower and stranger point is that the slow separation between the two lines is the only outward trace of the step just described.

What happens on this route in the years after the purchase?

Everything else does. Most descriptions of distribution leave this step out entirely, and leaving it out is exactly what makes the whole arrangement look like a single sale with a fee stapled to it.

Consider what actually travels this route after day one. A change of bank account. A nomination updated after a death in the household. An additional purchase in a good year. A switch. A partial redemption to settle a hospital bill. A systematic instruction that has to be paused for four months. A phone call in a bad month from somebody watching a value fall and wanting to know whether to stop. Every one of those runs down the same route, is handled by or through the same party, and is recorded against the same folio.

The arrangement continues instead of ending at the sale, and the component inside the ratio pays for the years rather than for the sale. That is why the accrual is daily and open ended instead of a single charge collected at the point of purchase.

Two structural shapes exist for how a distributor is paid out of that component. In one, part of the payment is made around the time of the sale itself. In the other, the payment accrues while the units continue to be held, and it stops when they go. Whether either shape applies to a given scheme, in what proportion, subject to what limit, and whether anything has to be returned if units leave soon after they arrived, are all matters SEBI decides. One structural point holds whatever the rule turns out to say. A payment that accrues while the holding stays is a payment for the holding staying, and that is why the years afterwards belong on the route rather than in a footnote to it.

What does one Rs 1,00,000/- purchase look like along the whole route?

Here is the walk in one place, on the Girnar Large Cap Equity Fund. A household in a district town brings Rs 1,00,000/- to a distributor who has been looking after their folios for years. Read the table downward and notice how few rows involve any arithmetic at all.

Three things in that table are worth pausing on. The value per unit is struck once by the scheme rather than negotiated on the way in, so the division was Rs 1,00,000/- over Rs 35.00 whichever route the money came by, and the scheme struck one value of Rs 35.00 that day without splitting it by plan. The rounding gave the folio half a paisa more than the exact arithmetic, a rounding convention doing its job rather than anybody being generous. And the last row is the most important of the three. The terms between the manager and the distributor fix that figure privately, so the route was walked from end to end, in rupees, without a single commission rate.

What does the route never change?

Not the securities. Not the weights. Not Kalyani Bhagat, who runs the portfolio either way. Not the method by which the value of one unit is struck, and not the value itself. The scheme strikes one value of Rs 35.00 on that day and never splits it between the two plans.

Two things change, and both of them are administrative. Which plan's expense ratio applies to those units, for as long as they are held. And who is recorded beside them.

The route changes what the holding costs and who is on the record beside it, and it changes nothing whatsoever about what is held. Both of the common mistakes about distribution are failures of exactly that sentence, in opposite directions.

Girnar Asset Management Limited, the Girnar Large Cap Equity Fund, Kalyani Bhagat and Sohail Merchant are invented.
Educational material. Not advice on any investment, tax, budget or market position.