Case 042AMC and distribution economicsCore

Direct plans rise from 25% to 55% of an AMC's new equity flows. Direct plans charge 0.8% less, and the AMC stops paying that 0.8% as trail. What happens to the AMC's net revenue, to distributors and to investors?

The situation

Sugamya Mutual Fund raises about Rs 12,000 crore a year of new money into its equity schemes. Until recently 25% came through direct plans, bought straight from the AMC or through platforms that charge investors separately; the rest came through distributors in regular plans. This year the direct share has jumped to 55%.

For its flagship equity fund, the regular plan charges 1.8% a year, of which the AMC pays the distributor 0.8% as trail commission; the direct plan charges 1.0% and pays no trail. The board asks what the shift means for the AMC's revenue, and the head of sales warns that distributors are unhappy.

Your task

What happens to the AMC's net revenue, to distributors and to investors, and what is the real risk to the AMC?

Quick check

On each rupee that moves from regular to direct, what happens to the AMC's own revenue?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

On each rupee the AMC's net revenue is roughly unchanged at about 1.0%; the 0.8% moves from distributors to investors. A 30-point shift on Rs 12,000 crore of yearly flows moves Rs 3,600 crore, so distributors lose about Rs 28.8 crore of trail a year for each year's flows and investors keep the same. The AMC's real risk is volume: if unhappy distributors push 10% less, it loses about Rs 12 crore a year of revenue.

Step 1Where does the expense ratio actually go?

When you buy a train ticket through an agent, the railway gets the same fare either way; the agent's fee is added on top, and buying at the counter saves you only the fee. In a regular plan the AMC collects the higher expense ratio and passes the trail to the distributor, so moving a rupee to direct removes the trail without touching the AMC's share. Here the AMC keeps 1.0% in both plans. The 0.8% that was trail commissionAn ongoing yearly payment from the AMC to the distributor, a percentage of the assets the distributor brought in, paid for as long as the money stays. becomes the investor's saving.

The shift to direct moves money from distributors to investorsRegular plan: 1.8% a yearAMC keeps 1.0%Distributor trail 0.8%Direct plan: 1.0% a yearAMC keeps 1.0%Investor keeps 0.8%the 0.8% stays with the investorDirect share of new equity flows rises from 25% to 55%: Rs 3,600 crore a year movesDistributors lose about Rs 28.8 crore of yearly trail per year's flows; investors keep the same amountThe AMC still earns 1.0% on every rupee, but only on the rupees that still arrive
In the regular plan the 1.8% expense ratio splits into 1.0% kept by the AMC and 0.8% paid to the distributor; in the direct plan the AMC still keeps 1.0% and the 0.8% stays with the investor, so the shift moves money from distributors to investors.
Step 2How large are the amounts for each party?

Thirty points of Rs 12,000 crore is Rs 3,600 crore a year moving to direct. Distributors lose about Rs 28.8 crore of yearly trail for every year's flows that go direct, and the loss stacks up as each new year's money is added. Investors keep the same amount. For one investor the gap compounds: Rs 10 lakh earning 12% before costs for ten years grows to about Rs 26.4 lakh in the regular plan and Rs 28.4 lakh in the direct plan, a difference of about Rs 2.0 lakh.

Per year, on one year's new flowsRs crore
Flows moving from regular to direct3,600
Trail distributors no longer earn, 0.8%-28.8
Expense investors no longer pay, 0.8%+28.8
AMC revenue on those flows, 1.0% either way36.0 both ways
AMC revenue at risk if gross flows fall 10%-12.0
On Rs 3,600 crore of flows moving to direct, distributors lose and investors gain about Rs 28.8 crore a year while the AMC's revenue is unchanged, but a 10% fall in gross flows would cost the AMC about Rs 12 crore a year.
Step 3So where is the AMC's real risk?

In volume, not in margin. Distributors are the AMC's sales force, and a channel that earns less from the AMC's funds may recommend them less. If gross equity flows fall 10% as a result, the AMC loses about Rs 12 crore of revenue a year on each year's flows, a real loss, where the shift to direct itself cost it nothing. It may also have to spend to win direct investors through platforms and marketing, which erodes the 1.0% it keeps.

Investors gain in fees, but some lose advice. A direct investor who chases last year's winner or stops an SIP in a fall can give back more than 0.8% a year. The AMC's sensible response is to keep serving distributors who add advice, invest in investor education for the direct channel, and track flows by channel monthly; the head of sales is right to be worried, just not about the margin.

Where candidates lose it

The common loss is saying the AMC's revenue falls 0.8% on every rupee that goes direct. The trail was never the AMC's income; it was collected and passed on, so the AMC's own share is unchanged.

The second miss is stopping at unchanged and missing the channel risk. The question about distributors is there because their behaviour, not the fee split, is what moves the AMC's revenue.

What the interviewer asks next

  • How would you design a pricing response for a registered investment adviser channel that charges investors directly?
  • Direct flows are concentrated in one fund-buying platform. What new risk does that create?
  • If SEBI capped total expense ratios further, which of the three parties absorbs the cut first?

Company names and figures are illustrative.