Fee always makes a difference to the outcome. Stop following the Herd

Till the establishment of the National Stock Exchange, anyone who wanted to buy shares approached brokers of the Regional Stock Exchanges who either bought the shares on their own exchange if it was traded or bought it on another exchange on which the stock got traded.

There were two kinds of fees that brokers levied. One was the brokerage which was anywhere between 3 to 5 percent of the transaction amount depending upon whether the stock was traded at the exchange where the broker was a member or on another exchange.

Of course, this was the known fees that were paid by the client. The unknown fees were that of the difference in price between where the share was originally bought or sold and the price reported to the client.

It was not a surprise that Regional exchange membership commanded mind-boggling prices. Most exchanges gave out a limited number of membership cards. The scarcity of the membership card combined with the opportunity to make a bundle meant that come rain or shine, prices of the membership card barely went down.

To compensate for the high fees, each member was allowed to bring in a few more authorized assistants into the trading ring. Even at exchanges where volumes weren’t really great, the price for becoming an authorized assistant wasn’t cheap.

Time and Tide wait for none and so it has been for the stock brokers. First came SEBI which restricted maximum charge that a broker could levy at 2.5%. Establishment of the National Stock Exchange was the real deal breaker when it came to membership prices. Operating on basis of Deposits only, NSE literally pulled the rug from under the feet of other stock exchanges.

Brokerage rates have been on a downward trend since then though establishment of Zerodha in 2010 with its per trade brokerage at first and later going in for free brokerage for delivery trades. Incidentally, the US seems to be catching the same bug with JP Morgan following the lead of Robinhood in offering free brokerage.

The key reason for falling brokerage was not because of the SEBI law which still held brokers could charge 2.5% but because National Stock Exchange removed once and for all the arbitrage held by brokers. Since becoming a broker was now easy and much of the deposit was refundable. Demand and Supply leveled the playing field once and for all.

Few days back, all hell broke through when Morning Star released its Morning Star Global Fund Investor Experience Report 2017.

India has a very good score in many aspects. 100% of mutual funds in India revealed their portfolio’s on a monthly basis, something that no other country in the list comes close. Indian Mutual funds also have the lowest time lag from end of month to release of portfolio holding details at 11 days. The worst is Hong Kong at 113 days.

The key reason for the anger lay in the section of Fee and Expenses. India saw a drop from its previous standing to now be part of the Below Average category. While Fees are indeed higher compared to other countries, Front Load not being present should have added value for they too are a part of the Expense Ratio, at least for the First year of investment.

Its thanks to SEBI in large part that today we are able to enjoy a low brokerage structure that is absent in most other countries. But it’s the same SEBI that seems to be the hurdle when it comes to opening up of the financial sector for competition.

While RBI restricts Banking Licenses making it nearly impossible to compete with existing banks, SEBI by way of minimum capital requirement has made it tough for competition to emerge.

In 2014, SEBI raised the Networth required to become a Mutual Fund from 10 Crores to 50 Crores. In one step, SEBI killed the competition that could have come up with interesting and new products. Over the last few years, we have actually seen a decline in the number of fund houses as small and non-viable firms looked for an exit.

Take for example, the United States where anyone can set up a Mutual Fund with Setup costs typically between $75,000 to $100,000. At the higher end, this is more or less 2x the Per Capita Income (PPP).

Indians are flocking to mutual funds like never before. The key reason is not just the strong advertising that showcases the advantages but the fact that the alternative asset classes was not delivering the goods.

Interest rates had fallen and with it being taxed at bracket levels, Fixed Deposits was not seen as appetizing. Real Estate which long had been and continues to draw investors hit a wall as after years of galloping returns, prices have more or less flattened.

During these times, Equity markets rose like a phoenix and rewarded those who were invested handsomely.

But asset classes don’t always move in a single direction. Equity markets have been going up like there is no tomorrow (these days, its mostly limited to large cap), the earnings which are not rising in the same breadth means that sooner or later, this rally too will fizzle out.

While bear markets are part and parcel of any stock market, paying excess fee can mean that your own returns are sub-optimal even though you may have had the knowledge that many others don’t when it comes to investing in equity.

With no new fund houses on the anvil, active funds in India have the upper hand. But that doesn’t mean that one has to pay through the nose for there are many a simple alternatives – Exchange Traded Funds (ETF’s) and Index funds which while not promoted can in the long term provide you similar returns thanks to their lower fee structure.

While an investor who is clueless about the world of finance may be easy to be misled, why are you, a person who knows better following the herd?