The Mutual Fund Distributor Commission is the main source of income for professionals who assist clients with buying and holding mutual funds. If you wish to become a distributor or simply be an informed investor, it is helpful to know this commission structure. The commission is made by the Asset Management Company (AMC) directly from the fund, and is paid from a portion of the fund's Total Expense Ratio (TER) of the regular plan. The investor does not pay this commission directly.
What is the Mutual Fund Distributor Commission?
The Mutual Fund Distributor Commission is the payment made by an Asset Management Company (AMC) to an authorized distributor for:
Bringing investments into their mutual fund schemes.
Providing continuous services to the investor, including, but not limited to, investment recommendations, portfolio reviews, execution of transactions, and keeping them invested in the long term.
This commission will be calculated as a small percentage of the Assets Under Management (AUM) that the distributor mobilizes and keeps invested. This is an additional cost that is incorporated into the cost structure of the regular plan; a ‘Direct Plan’ will pay no commission and usually has a lower expense ratio.
Before being eligible for the commission, you must have the appropriate licensing or certification, of which the NISM Series VA Mutual Fund Distributors Course is one such example.
How Mutual Fund Distributor Earns?
Mutual Fund Distributors (MFDs) have a structured and regulatory-compliant mechanism to earn a fee. Their fee does not come once but as a recurring fee based on the size and duration of the assets under management they maintain. The primary mode an MFD earns is through a Trail Commission.
The primary components of an MFD's revenue include the following:
Assets Under Management (AUM): The total value of the investments in the underlying fund that are attributed to the distributor's code. As commissions are a percentage of AUM, a larger AUM represents a larger fee.
Fund Category: Different types of funds (Equity, Debt, Hybrid, etc.) have differing Total Expense Ratios (TER) and different commission rates.
Staying Invested: The fee paid to the MFD remains so long as the investor is invested. This incentivizes the distributor to provide useful and long-term advice and deters them from recommending the frequent transfer of the investor's investments (churning).
Types of Mutual Fund Distributor Commission
MFDs compensation has changed significantly under SEBI (Securities and Exchange Board of India) regulations in order to increase transparency and better align distributor compensation with long-term investor goals.
Trail Commission (The Primary Earning)
The Trail Commission is the current and most widely used mutual fund distributor commission type.
Nature: It is an ongoing check payment to the distributor for a small annualized percentage of the investor's daily AUM.
Duration: Paid for as long as the investor is invested in the fund.
Reason: Compensates the distributor for continuous service, servicing the investor, and managing the investor's portfolio over time.
The commission ensures a distributor is compensated for holding the investor over the long term rather than just a one-time sale.
Upfront Commission (Largely Phased Out)
Nature: This was a one-time, lump payment made to the distributor at the time of the investment.
Status: SEBI has terminated the practice of payment of upfront commissions on mutual fund investments in regular plans to limit mis-selling schemes only for upfront commissions.
Exception (Special Incentives): The traditional upfront commission is gone. However, incentives for New Fund Offers (NFO), for example, could be used for investment in specific geographies, structured to increase distribution reach.
B-30 Incentives (A Regulatory Initiative)
The B-30 (Beyond Top 30) incentive is a unique commission structure developed by SEBI and AMFI (Association of Mutual Funds in India) to increase mutual fund penetration in smaller cities and towns outside of the top 30 (T-30) cities.
Structure: Asset Management Companies (AMCs) can charge an additional expense ratio (historically up to 30 basis points [0.30%] of total expense ratio) on net new inflows from B-30 cities, and the full amount of the expense ratio is passed along as an incentive to the distributor.
Purpose: Compensate MFDs for the incremental effort and expense to reach investors in less penetrated markets.
Regulatory Changes: The structure is subject to periodic review and change by SEBI to address issues such as churning and ensure the structure meets its purpose of expanding the markets genuinely.
Why Commission Rate Vary?
The commission rate for a Mutual Fund Distributor Commission is not rigid and varies along with several regulatory and market-based factors:
These factors and differences can make a significant difference to professionals. Consider going deeper, with courses such as the Research Analyst Certificate Course or Investment Analysis and Portfolio Management Course to obtain those key skills.
Practical Guide & Calculation
Mutual Fund Distributor Commission is calculated based on the daily value of the Assets Under Management (AUM) and is paid out on a monthly or quarterly basis.
Commission Calculation Formula
The method most commonly used to calculate the daily trail commission is:
Daily Commission = Investor’s AUM × Annual Trail Commission Rate / 365
The final monthly or quarterly payout will be the total of these daily commissions.
Example Calculation
For purposes of an example, let us assume:
Investor AUM (Value of Investment) on any given day: Rs. 1,00,000
Annual Trail Commission Rate: 0.75% (or 0.0075 in decimal)
Number of Days: 30 days
Calculate the daily commission:
Daily Commission = Rs. 1,00,000 × 0.0075 / 365 ? Rs. 2.05
Calculate the monthly payout (assuming AUM is constant):
Monthly Commission = Rs. 2.05 × 30 ? Rs. 61.50
In truth, the AUM will change daily due to the scheme’s Net Asset Value (NAV), and the AUM will change based on new investments or redemptions, so using a daily retain calculation is the most accurate method.
Total Earnings Potential
The key to achieving a high income from Mutual Fund Distributor Commission is to have a large and stable AUM.
Let’s say a Mutual Fund Distributor has an AUM of Rs. 5 Crore (OR Rs. 5,00,00,000), and the average commission rate is 0.60%, then every year that Mutual Fund Distributor will receive the annual commission of: Rs. 5,00,00,000 × 0.0060 = Rs. 3,00,000.
To increase income, one must focus on growing their ratio of AUM, either through client retention of pre-existing clients who increase their SIPs or lump-sum investments, or through new clients. The most important step to retaining or attracting any client is to have the most appropriate professional knowledge, which can be accomplished, to at least some extent, through the SEBI NISM Preparation Courses. The specific module relevant to the Mutual fund distributors is the NISM Series VA certification module, which is the critical first step.
Conclusion
The distribution commissions applied to Mutual Funds have been organized based on a very intelligent system, paying trail commissions to distributors for long-term guidance and investor retention. The system manages to keep the distributor's financial success tied to the financial success of the investor, helping the investor to understand that the commissions are part of the fund's expense ratio, in appreciating how the Regular and Direct plans are different. For an MFD, achieving financial success most often includes obtaining the proper certifications to provide a consistent service, and providing potential clients with the proper use of economics and incentives, such as the B-30 commission, and acquiring the proper AUM to create solid, long-term AUM.
To advance your career in financial services and develop better knowledge of market conditions, you might want to consider a program such as:
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