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

Tired of your mutual fund distributor ignoring your calls or providing subpar service? It’s time for a change. But unlike switching grocery stores, changing your mutual fund distributor (MFD) comes with a few complexities. If not done correctly, your old distributor will continue to pocket commissions from your holdings. Here’s how to ensure that doesn’t happen.

Two ways to shift your assets

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

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

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

Redeem and reinvest: This route involves selling your current mutual funds and purchasing new ones through the new MFD. While it might seem like a clean break, beware—selling triggers capital gains tax. Recent changes in tax laws have made this option even more costly. For instance, the capital gains tax on equity mutual funds was raised in this year’s budget, which could significantly eat into your long-term returns.

Transfer existing schemes: Alternatively, you can transfer your funds directly to the new MFD without selling. However, this option had a significant drawback until recently. From 2010 to March 2024, neither the new distributor nor the old distributor received any commission when such a transfer occurred. This lack of financial incentive discouraged MFDs from facilitating these switches. Instead, they benefited when clients sold their existing schemes 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 payout is based on the lower commission rate between the old and new distributor. For example, if the old MFD was earning 40 basis points annually and the new MFD charges 45 basis points for the same scheme, the new MFD would have to settle for a 40 basis point yearly commission. This rate is agreed upon between the MFD and the AMC within the total expense ratio.

However, this commission isn’t paid out immediately. There’s a six-month cooling-off period. So, if you switch your MFD on 1 April 2024, the new distributor will only start receiving commissions from September 2024. Conversely, if you sold and bought a new mutual fund under the new MFD’s code, the distributor would earn commissions for the entire 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 might be lower than what the previous MFD earned. It’s important to note that while the total expense ratio remains consistent for all investors, the commission percentage can vary between different MFDs.

One unresolved issue is what happens to the commissions during the six-month cooling period. Questions sent to Association of Mutual Funds in India remained unanswered till press time.

“The assumption is that the AMC keeps the commission with themselves in the six-month cooling period since the same expense ratio is charged to the client for that period,” said Amol Joshi, founder, 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 more straightforward than you might think. Here’s how it works:

First, you’ll 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). On this form, you’ll fill in details such as your folio number and the ARN codes of both the previous and new brokers. 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 schemes are now managed by the new MFD. However, you’ll need to submit this form to each AMC where you have investments—a process typically handled by the new MFD on your behalf.

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

It’s important to note that currently, there’s no option to shift your mutual fund investments from a regular plan to a direct plan without incurring capital gains tax.

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’s ARN code to a new MFD ARN, the new ARN holder didn’t earn any commissions. Now, with commissions starting after the six-month period, it becomes more financially viable for these managers to launch their own MFD practices.

Key considerations

Before making a switch, be wary of 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 raised short-term capital gains from 15% to 20% and long-term gains from 10% to 12.5%.

Moreover, some MFDs may push new fund offerings (NFOs) because these typically offer higher commissions than existing funds. Be cautious of such advice.

If you’re not satisfied with your new MFD, you have six months to revert to your old one without losing commissions to the new distributor. However, doing so restarts the cooling-off period. As Amol Joshi explains, this rule makes it harder for MFDs to make empty promises—they must prove their value within that six-month window.

Final thoughts

Switching MFDs can be a smart move if done carefully.

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Be sure to understand the implications of selling versus transferring your holdings, and always question the motivation behind any advice to sell existing funds. With the right approach, you can transition smoothly to a new MFD while keeping your investments working hard for you.