o Some AMCs directly empanel only distributors who are likely to generate

Adequate business – and request others to work under one or the other empaneled
distributors.

o At times, AMCs link the levels of commission to the volumes generated. In such
cases, an agent might find it beneficial to work under an established distributor.

While many of the above clauses would be included in the application forms, there is no
standard format, and each asset management company use their own format for collecting
such details, as well as for empanelment of distributors.

6.5 Revenue for a mutual fund distributor

The mutual fund distributor earns revenue in the form of commission income for the
distribution of the mutual fund products/schemes. The commission may be linked to either
the transaction or to the assets under management. Both these models have been explained
below.

When an individual transacts on the stock exchange through a stockbroker to buy or sell a
stock, the individual pays the brokerage commission to the broker. This is an example of a
transaction linked commission. On the other hand, the income to the Asset Management
Company accrues in the form of a percentage to the assets under management. In other
words, the transaction-based commission accrues at the time of a transaction, whereas the
AUM-linked commission is payable on an ongoing basis, so long as the investor remains
invested. As is evident, the transaction-based payment would largely be paid in one shot, the
AUM-linked commission would be payable over a period, and hence the commission would
be payable periodically. At the same time, there could be some arrangements wherein the
AUM-based commission is upfronted, which means the expected future AUM-based
commission for a certain period may be paid upfront at the time of purchase.

The mutual fund distributor could earn income in both ways in the earlier days. However, now
the only way a distributor can earn commission income is in the form of trail commission,which
is payable as a percentage of assets under management. As per the SEBI circular dated October
2018, AMCs shall adopt the full trail model of commission in all schemes, without payment of
any upfront commission or upfronting of any trail commission, directly or indirectly, in cash
or kind, through sponsorships, or any other route.

However, upfronting of trail commission is allowed only in case of inflows through Systematic
Investment Plans (SIPs) of up to Rs. 3,000 per month for an investor investing in mutual fund
schemes for the first time. If an investor starts multiple SIPs, the upfront commission can be
paid only in case of the SIP starting on the earliest date. In respect of inflows through SIPs, a

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carve-out has been considered for new investors to the mutual fund industry48. This carve-out
means upfronting of trail commission (payment of expected future trail commission upfront
at the time of the transaction), based on SIP inflows, shall be up to 1 percent payable yearly
in advance for a maximum period of three years. The need for ‘carve out’ would be reviewed
by SEBI as and when required and in case of misuse of the carve-out for SIPs, the same would
be discontinued and appropriate action would be taken against the errant participants.

The following carve out to be implemented by the AMCs:

• The upfronting of trail commission is applicable for SIP of up to Rs. 3000 per month, per
the scheme, for an investor who is investing for the first time in Mutual Fund schemes.

• For a new investor, as identified above, only the first SIP(s) purchased by the investorshall
be eligible for upfronting. In this regard, if multiple SIP(s) are purchased on different
dates, the SIP(s) in respect of which the instalment starts on the earliest date shall be
considered for upfronting.

• The upfront trail commission to be paid from AMC’s books.

• The said commission to be amortized on daily basis to the scheme over the period for
which the payment has been made. A complete audit trail of upfronting of trail
commissions from the AMC’s books and amortization of the same to the scheme(s)
thereafter to be made available for inspection.

• The said commission will be charged to the scheme as ‘commissions’ and should also
account for computing the TER differential between regular and direct plans in each
scheme.

• The commission is paid to be recovered on a pro-rata basis from the distributors if the
SIP is not continued for the period for which the commission is paid.

6.5.1 Concept of Trail Commission

Trail commission is calculated as a percentage of the net assets attributable to the Units sold
by the distributor. The commission payable is calculated on the daily balances and paid out
periodically to the distributor as per the agreement entered into with AMC.

The trail commission is normally paid by the AMC on a quarterly basis or monthly basis. Since
it is calculated on net assets, distributors benefit from increase in net assets arising out of
valuation gains in the market.

48SEBI circular no. SEBI/HO/IMD/DF2/CIR/P/2018/137 dated October 22, 2018 and Vide SEBI Circular No.:
SEBI/HO/IMD/DF2/CIR/P/2019/42 on Review on Commission, Expenses, Disclosure norms etc. - Mutual Funddated March 25,
2019.
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For example, suppose an investor has bought 1000 units at Rs. 10 each. The distributor who
procured the investment may have been paid an initial commission calculated as a percentage
on 1000 units X Rs. 10 i.e., Rs 10,000.

Later, suppose the NAV of the scheme goes up to Rs.15. Trail commission is payable on 1000
units * Rs 15 i.e., Rs 15,000 – not the Rs 10,000 mobilised. In short, trail commission depends
on the NAV.

Further, unlike products like insurance, where agent commission is paid for a limited number
of years, a mutual fund distributor is paid trail commission for as long as the investor’s money
is held in the fund.

Such indexing of agent commissions to the current value of the investment, and the absence
of a time limitation to earning it, are unique benefits that make it attractive for distributors
to sell mutual funds.

Let us take an example here. A distributor mobilised a sum of Rs. 10 lakhs on a particular day
when the scheme’s NAV was Rs. 10.0000. The total units allotted were 1,00,000.

In this case (Rs. 10,00,000 / Rs. 10.0000). We have assumed a trail commission rate of 1% p.a.
in this case. Given below is the table showing calculation of trail commission for the month of
July 2019. (All NAVs are randomly generated, and not of any actual scheme).49

No. of units allotted = 1,00,000 at NAV of Rs. 10.0000

Trail Commission is 1 percent of Value i.e., Rs.10,00,000 and subsequently as the NAV changes,
the value changes.

49This is taken only for the purpose of the calculation and in no way is any indication of the trail commission payable.
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Table 6.1 Calculation of trail commission for distributors

Trail
NAV Value commission
Date (A) (B) (B*1%/365)
01-Aug-19 10.0000 10,00,000.00 27.40
02-Aug-19 10.0270 10,02,698.66 27.47
03-Aug-19 10.0270 10,02,698.66 27.47
04-Aug-19 10.0270 10,02,698.66 27.47
05-Aug-19 9.9140 9,91,396.69 27.16
06-Aug-19 9.9888 9,98,879.74 27.37
07-Aug-19 9.9114 9,91,144.38 27.15
08-Aug-19 10.0835 10,08,348.30 27.63
09-Aug-19 10.1522 10,15,224.62 27.81
10-Aug-19 10.1522 10,15,224.62 27.81
11-Aug-19 10.1522 10,15,224.62 27.81
12-Aug-19 10.1522 10,15,224.62 27.81
13-Aug-19 9.9837 9,98,374.86 27.35
14-Aug-19 10.0792 10,07,920.67 27.61
15-Aug-19 10.0792 10,07,920.67 27.61
16-Aug-19 10.0897 10,08,968.80 27.64
17-Aug-19 10.0897 10,08,968.80 27.64
18-Aug-19 10.0897 10,08,968.80 27.64
19-Aug-19 10.1038 10,10,377.83 27.68
20-Aug-19 10.0837 10,08,365.86 27.63
21-Aug-19 10.0114 10,01,135.92 27.43
22-Aug-19 9.8527 9,85,267.02 26.99
23-Aug-19 9.9143 9,91,432.35 27.16
24-Aug-19 9.9143 9,91,432.35 27.16
25-Aug-19 9.9143 9,91,432.35 27.16
26-Aug-19 10.1285 10,12,853.10 27.75
27-Aug-19 10.1683 10,16,828.15 27.86
28-Aug-19 10.1171 10,11,710.96 27.72
29-Aug-19 10.0137 10,01,367.16 27.43
30-Aug-19 10.0849 10,08,494.98 27.63
31-Aug-19 10.0849 10,08,494.98 27.63
Total trail commission for the period: 853.13

In the above example, the trail commission is calculated for each day using the below formula:

Trail commission for the day = AUM X trail commission rate p.a./365

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Since the trail commission rate is mentioned as percent per annum, the same needs to be
divided by 365 to arrive at the daily trail commission amount.

Smart distributors have accumulated a portfolio of loyal investors to whom they offer superior
service. The trail commission on these investments ensures a steadily rising income for the
distributor. Additional investments from the same investors, and other investors referred by
the current investors, help them grow the portfolio.

A point to note is that the commission is payable to the distributors to mobilize money from
their clients. Hence, no commission is payable to the distributor for their own investments
(self-business).

Regulations require distributors to disclose to their investors all commissions in the form of
trail commissions or any other form payable to them from similar competing schemes of a
different mutual fund from amongst which the particular scheme was recommended to the
investor.

Example of upfronting of trail commission50

As discussed earlier, SEBI has allowed the payment of upfront commission in certain cases.
The same can be understood by making suitable modifications to the example of trail
commission shown above. If the trail commission payable for the first month was to be
upfronted, the distributor is likely to receive the commission of Rs. 849.32. The same is
calculated as under:

Investment amount: Rs. 10,00,000

Trail commission rate: 1 percent p.a.
Trail commission for a year: Rs. 10,00,000 X 1 percent = Rs. 10,000
Trail commission for a day: Rs. 10,000/365 = Rs. 27.397 (Trail for a year is divided by the
number of days in a year)

Trail commission for July payable in August 2019 = Rs. 27.397 X 31 (there are 31 days in July,
hence the daily trail commission amount is multiplied by 31) = Rs. 849.31

As can be seen here, the distributor gets an upfront commission without factoring in the
change in NAV over the period. This is logical. Since the commission is paid upfront, there is
no way to reliably predict the daily NAV movement for the period for which the trail is
upfronted.

6.5.2 Additional commission for promoting mutual funds in small towns

With a view to promoting mutual funds in smaller towns, SEBI has allowed mutual funds to
charge additional expenses, which can be used for distribution related expenses, including

50This is for illustration purpose only.

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