Is your mutual fund distributor letting you down? Here’s how to switch

Are you tired of your mutual fund distributor ignoring your calls or providing poor service? It’s time for a change. But unlike switching supermarkets, switching mutual fund distributors (MFDs) comes with some complexities. If not done correctly, your old distributor will continue to pocket fees from your holdings. Here’s how to make sure that doesn’t happen.

Two ways to transfer your assets

When switching MFDs, you basically have two paths: redeem your funds and invest with the new distributor, or transfer your existing schemes to the ARN code of the new MFD.

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For years, the mutual fund industry has been a cozy ecosystem in which distributors had a significant advantage. Switching distributors often meant selling existing holdings and reinvesting in new schemes, which incurred capital gains taxes that could erode their returns. Moreover, distributors had little incentive to facilitate direct transfers without selling, as they received no fee income.

However, the landscape has changed. Let’s explore your options under the new rules.

Redeem and reinvest:This option involves selling your current mutual funds and buying new ones through the new MFD. While it may seem like a clean break, beware: the sale triggers a capital gains tax. Recent changes in tax laws have made this option even more costly. For example, the capital gains tax on equity mutual funds was increased in this year’s budget, which could significantly impact your long-term gains.

Transfer existing schemas: Another option is to transfer the funds directly to the new distributor without selling them. However, this option had a major drawback until recently. From 2010 until March 2024, neither the new nor the old distributor received any commission when such a transfer occurred. This lack of financial incentives discouraged distributors from facilitating these changes. Instead, they benefited when customers sold their existing plans and reinvested in new ones.

But the rules changed after March 2024. Now, when you switch MFDs, the new distributor is entitled to a commission. Here’s how it works: The payment is based on the lowest commission rate between the old and new distributor. For example, if the old MFD was earning 40 basis points per year and the new MFD charges 45 basis points for the same scheme, the new MFD would have to settle for an annual commission of 40 basis points. This rate is agreed between the MFD and the AMC within the total expense ratio.

However, this commission is not paid immediately. There is a six-month cooling-off period. So, if you change your MFD on April 1, 2024, the new distributor will only start receiving commissions from September 2024. In contrast, if you sold and bought a new mutual fund under the new MFD code, the distributor would earn commissions throughout the year.

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For example, if you transfer HDFC Flexi Cap from your old MFD to the new one, the new distributor will start receiving commissions on those investments after six months. However, this commission may be lower than what the previous MFD was earning. It is important to note that while the total expense ratio remains constant for all investors, the commission percentage may vary across different MFDs.

One outstanding question is what happens to fees during the six-month dormancy period. Questions sent to the Mutual Funds Association of India remained unanswered by the time of publication.

“The AMC is supposed to pocket the commission during the six-month cooling-off period as the client is charged the same proportion of expenses during that period,” said Amol Joshi, founder of PlanRupee Investment Services. However, this remains speculative as nothing has been officially confirmed.

Step by Step: How to Change Your MFD

The process of changing your MFD is easier than you think. Here’s how it works:

First, you will need to sign a “Change of Broker” form, which you can obtain from the AMC (asset management company) or the relevant Registrar and Transfer Agent (RTA). In this form, you will need to fill in details such as your folio number and ARN codes of both the old and new broker. Once submitted to the AMC or RTA, the mutual fund company will verify your signatures and update the ARN code to reflect the new MFD. RTAs are the entities responsible for maintaining investor data and managing the transfer of investments.

For you, the investor, nothing changes except that your plans are now managed by the new MFD. However, you will need to submit this form to each AMC where you have investments, a process normally handled by the new MFD on your behalf.

If your investments involve joint holdings, signature verification of all holders will be required.

It is important to note that currently, there is no option to move your mutual fund investments from a regular plan to a direct plan without incurring capital gains taxes.

According to Ankit Garg, founder of My Money Mantra, this new system also makes it easier for bank relationship managers to start their own MFD practice. Previously, when clients transferred their holdings from a bank ARN to a new MFD ARN, the new ARN holder did not earn any commission. Now, with commissions starting after the six-month period, it is becoming more financially viable for these managers to start their own MFD practices.

Key Considerations

Before you make a switch, watch out for certain red flags. If your new MFD suggests selling existing holdings to buy new funds, ask why. This could trigger a capital gains tax, particularly after the Union Budget 2024 increased short-term capital gains from 15% to 20% and long-term gains from 10% to 12.5%.

Additionally, some MFDs can push New fund offerings (NFO) because they often offer higher fees than existing funds. Be careful with this type of advice.

If you’re not happy with your new MFD, you have six months to switch back to the old one without losing commissions to the new distributor. However, doing so resets the cooling-off period. As Amol Joshi explains, this rule makes it harder for MFDs to make empty promises – they have to prove their worth within that six-month period.

Final thoughts

Changing MFDs can be a smart decision if done carefully.

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Make sure you understand the implications of selling or transferring your holdings and always question the motivation behind any advice to sell existing funds. With the right approach, you can make a smooth transition to a new MFD and keep your investments working hard for you.