Investing in mutual funds set to get cheaper for investors

Express News Service

MUMBAI:  In its quest to make the mutual fund industry more transparent and reduce the cost of investment for retail investors, the Securities and Exchange Board of India (Sebi) has floated a consultation paper with a raft of proposals related to fees and expenses charged by the Asset Management Companies (AMCs).

In its proposals, the capital market regulator wants mutual funds to cut the cost for investors and bring all the fees and charges under the total expense ratio (TER). If implemented in the current form, the proposal will make investing in the mutual fund a lot cheaper for retail investors and will significantly increase their returns in the long term.

What does Sebi want?
In a consultation paper released last month, Sebi has proposed a uniform TER across mutual fund schemes in a bid to bring transparency to the costs charged to unitholders.

At present, Sebi allows AMCs to charge unitholders of mutual funds four additional types of expenses over and above the specified TER limits. These are brokerage and transaction costs, additional TER for distribution commission for inflows from B-30 (beyond top 30) cities, goods and services taxes and other expenses for exit loads.

The TER is a percentage of a scheme’s corpus that a mutual fund house charges towards expenses including administrative and management. Sebi has proposed that AMCs should include all additional expenses like GST, Securities and Transaction Tax (STT), brokerage and other charges under TER.

Taking note of reports about the underperformance of mutual fund schemes, the regulator has also proposed the concept of performance-based fees for mutual fund schemes. “The move towards performance-based fee structures can drive healthy competition and encourage AMCs to deliver superior results, benefiting investors and the mutual fund industry,” Gopal Kavalireddi, Vice President – Research at Fyers told this newspaper.

Reducing cost for investors
One of the significant benefits expected from these proposals is lowering the cost of investing in mutual fund schemes and an increase in the returns for investors in the long-term. With AMCs not allowed to charge fees beyond the limit prescribed by the regulator, several equity, debt and hybrid schemes of the mutual funds may get cheaper after the implementation of the proposals.

“It is anticipated that expenses on certain funds, particularly those managed by larger AMCs and falling under sectoral or thematic categories, will witness a decline. Furthermore, the proposal to incorporate additional charges such as brokerage and taxes within the overall expense ratio limit is expected to curtail the variability experienced beyond the current total expense ratio,” Anand Dalmia co-founder and CBO at Fisdom told TNIE.

“The introduction of performance-based fees is another noteworthy proposal, which aims to align expenses with fund performance, ensuring a stronger correlation between value delivered to investors and costs incurred. Overall, investing in mutual funds can be expected to get more cost-effective,” Dalmia added.

The Mutual Fund Industry has grown significantly over the last few years with a considerable increase in the participation of retail investors. Currently, there are 42 players in the mutual fund industry that manages an asset base of over R40 lakh crore. The Asset Under Management (AUM) of the MF industry stood at R41.62 lakh crore at the end of April this year.  

“With the proposed changes, expense ratios will be reduced for mutual fund schemes. Introducing performance-linked expense ratios will incentivise AMCs to deliver better returns to investors. This shift towards a more performance-based fee structure will benefit investors by aligning the charges with the returns,” said Kavalireddi. “Through the proposals in the consultation paper, Sebi aims to facilitate cost effectiveness, greater transparency, and accrual of benefits of economies of scale to investors,” he added.

Impact on AMCs
Larger AMCs are expected to be affected by the new proposal as they have a higher number of funds surpassing the proposed expense ceiling and experts expect the proposal to level the playing field for large and smaller AMCs.

“The TERs of AMCs with larger Equity AUMs will come down by a few basis points. It could result in lower trail commissions and the profitability of the AMCs as well,” Sandeep Bagla, CEO, Trust Mutual Fund told this newspaper. “The smaller AMCs could gain as they would be able to pay out higher commissions to distributors,” he added. The mutual fund industry is dominated by a few larger players with the top eight fund houses accounting for around 75% of the total industry AUM at the end of March this year.

“The proposed guidelines are likely to result in the rationalisation of expense ratios for numerous funds managed by larger asset management companies. This is due to the fact that larger AMCs tend to have a higher number of funds that surpass the proposed expense ceiling,” said Dalmia. “Conversely, smaller AMCs may find themselves with more flexibility to increase expenses as the proposed ceiling provides them with ample headroom,” he added.

Not everyone seems happy with the new plans and some stakeholders have expressed apprehensions about these proposals. “Most retail investors invest in equity mutual funds to benefit from the growth of the Indian economy and companies and the expertise and experience of the fund management team. No one invests with an eye to reduce costs or expenses,” said Bagla. “If AMCs start rationalising costs and it results in poorer service and fund performance, the whole move could be counterproductive. The unintended consequences could be an overall deterioration in fund quality and performance that could be expensive for the investor in the long run,” he added.