In the last few days there has been a big hula boo about the so-called ‘deftly’ crafted changes brought about by the capital market regulator - Securities and Exchange Board of India (SEBI), attempting to ‘revitalise’ the mutual fund industry. Mutual Fund industry as we know, has been reeling under pressure to encourage more participation in various mutual fund schemes and expand its reach beyond the major cities since the ‘entry load’ ban in August 2009.
Thus going by its intent to revitalise the mutual fund industry, the SEBI has now permitted Asset Management Companies (AMCs) that have managed to bag 30% of their total annual inflows from places beyond top-15 Indian cities to charge an additional 30 basis points (bps) expense ratio. The 30 bps would be charged on the entire fund, in a way, making existing investors and investors residing in top cities to pay for new investors from the hinterlands. This, in effect, would jack up the expense ratio by 30 bps to 2.80% in the case of equity funds with assets over Rs 100 crore.
Until now, out of the 2.50% charged as expense ratio (under equity schemes), fund houses are allowed to charge only 1.25% towards asset management charges, and the remaining 1.25% goes in towards meeting recurring expenses, such as transaction costs, registrar charges dealing charges to empaneled brokers and selling & distribution cost. But under the new guideline to revitalise the mutual fund industry, SEBI has also allowed for fungibility in "expense ratio", whereby the cost bifurcation will cease to exist, and the fund houses will be permitted to charge for the aforesaid expenses at will.
Likewise for the exit load too, SEBI has asked fund houses to plough back entire exit load to the NAV of the fund. Until now, fund houses used to charge only a maximum of 1% as exit load; the rest was ploughed back to the NAV of the fund. But since SEBI’s main intention is to revitalise the mutual fund industry, the fund houses will now be allowed to claw back an additional expense ratio of 20 bps from the overall fund.
Apart from the above, the regulator has decided to create a separate 'direct (mutual fund) investment plan' - the schemes under which will bear lower expense ratio. Also, in order to help enhance the reach of mutual fund products amongst small investors, who may not be tax payers or have PAN and bank accounts, the regulator has allowed cash transactions in mutual fund schemes to the extent of Rs 20,000.
Taking a holistic view of the above mentioned changes, we believe that most of the changes mentioned by the SEBI are industry centric and accrue fewer benefits to investors as the ultimate cost of investing in mutual funds stands elevated. The move by SEBI to allow AMCs to charge the additional 30 bps, on the entire asset base as expense ratio (in case the AMCs are successful in generating 30% of their total AUM from cities other than top 15 cities) is rather unfair. An existing investor who has stayed invested in a particular scheme would now be subject to additional expense ratio just because the AMC starts business in cities other than top 15 cities in the country.
However on the flip side, with fungibility being introduced for expense ratio; competition is likely to stir up within the mutual fund industry to fetch a bigger pie of the Assets Under Management (AUM). Also with fungilibity aspect of expense ratio could be a tussling task for the mutual fund house itself - where they may confront questions such as; whether to remunerate the fund management team well (for better performance of a respective mutual fund scheme), or keep their distributors happy and provide for more transaction costs.
What should mutual fund investors do?
Primarily, we think that it is imperative for investors to select mutual funds prudently and have only winning diversified mutual fund schemes in their portfolio which suits their needs. Moreover, with expense ratio being increased it is vital to select winning mutual funds, because only the schemes who perform well on all parameters can turn to be rewarding - and it is important to invest in mutual funds - especially equity funds, with a long-term investment horizon. With the market scenario being volatile, it is prudent to invest in mutual funds vide the Systematic Investment Plan (SIP) mode of investing, as it will enable you benefit from rupee-cost averaging and compounding.