How SEBI’s Diktat On ‘Expense Ratio’ Will Benefit Investors
Sep 19, 2018

Author: PersonalFN Content & Research Team

Benefit Investors1909

“You need not incentivise to attract investors to mutual funds. You deserve a reward only if you can keep investors invested for the long haul.”

The message from the Securities and Exchange Board of India (SEBI) to mutual fund distributors is loud and clear.

At the same time, it has advised mutual fund houses to pull their socks up.

They have been silent about mis-selling their products; and, in fact, they have been going out of the way to lure their distributors to sell more.

One masterstroke from SEBI is about to change how the game is played now.

Recently, SEBI directed mutual fund houses to…

  • Bill schemes for all distribution and related expenses. In other words, mutual fund houses can’t incentivise their distributors by shedding their own profits—a practice that allowed big mutual funds to get bigger.
  • Stop paying upfront commissions and upfronting of trail commissions. Usually, fund houses do upfronting of trail commissions in case of Systematic Investment Plans (SIPs) subject to fulfilment of certain conditions.
  • Reduce Total Expense Ratios (TERs) as directed.
New Total Expense Ratio Structure…
AUM Slab (Rs in crore) TER for equity oriented schemes TER for other schemes (excl. Index, ETFs and Fund of Funds)
0-500 2.25% 2.00%
500-750 2.00% 1.75%
750-2,000 1.75% 1.50%
2,000-5,000 1.60% 1.35%
5,000-10,000 1.50% 1.25%
10,000-50,000 TER reduction of 0.05% for every increase of 5,000 crore AUM or part thereof TER reduction of 0.05% for every increase of 5,000 crore AUM or part thereof
>50,000 1.05% 0.80%
(Source: SEBI)
  • Moreover, cap TER of close-ended equity schemes at 1.25% and that of other than close-ended schemes at 1.0%.
  • Cap TER of Index Funds at 1.0%.
  • Restrict TER at maximum twice the TER of underlying fund In the case of Fund of Funds (FoF).
  • Stated that the additional 30 basis points (bps) expenses should be charged based on only inflows from retail individual investors from beyond the top 30 cities (B-30) and not corporates and institutions.
  • Pay B-30 incentive to distributors only in the form of trail commissions.
  • Disclose all schemes’ returns (category wise) vis-à-vis the total returns generated by their benchmark and display them on the AMFI website.
Further, SEBI has clearly stated that “Upon implementation of the above decisions, the Trustees and AMC Boards shall monitor the implementation by the respective AMCs and shall report to SEBI periodically.” So, fund houses will need to comply with these guidelines strictly.

How will this diktat benefit you, the investor?

diktat benefit you

By rationalising TER, the capital market regulator has aimed at bringing in transparency in the appropriation of expenses. This, in turn, would reduce the cost of investing in mutual funds for you.

Further, with strict implementation of these new rules, the Indian mutual fund industry is all set to become more transparent, perhaps mature, and investor-friendly.

Capping commissions and TER on close-ended equity-oriented schemes and making it mandatory to charge all distribution expenses to the schemes will curb mis-selling. Big distributors doing business, including private sector banks, who work on commissions, will have to recalibrate their business models. Their focus will shift from earning more upfront commissions to retaining customers in the same scheme for longer.

[Read: How Mutual Fund Distributors And Banks Cheat You]

Direct Plan of a mutual fund is likely to become more prevalent going forward. Mutual Fund advisors will have no choice but to aggressively push direct plans or would opt out of business.

Urban clusters, where the acceptance and adaptability of technology are higher, will see a shift away from human advisors and distributors to robo advisors.

PersonalFN Direct—a robo advisory platform offers only direct plans. Moreover, it provides customisable investment solutions based on your risk profiling and is backed by PersonalFN’s solid mutual fund research. To know more about PersonalFN Direct, click here.

Another point…

Of late, mutual fund houses have been aggressively launching close-ended equity-oriented schemes to bank on the vibrant investor sentiment and popularity of mutual funds. They have been luring distributors with fat commissions topped with freebies and goodies to push their close-ended offerings. Fund houses with deep pocket which can dip into their reserves to compensate distributors have been the frontrunners in the race of gathering more AUM. 

However, at this year’s Mutual Fund Summit that concluded recently, SEBI chief, Mr Ajay Tyagi hinted at even framing a new policy for close-ended schemes. Perhaps for the first time, the capital market regulator acknowledged that investors of close-ended schemes are more vulnerable to mis-selling.

The regulator has shown the mirror to fund houses that wish to grow their AUM only by strengthening their distribution channel, ignoring their poor performance.

The probable negative effects…

These norms have come at a time when mutual funds were getting popular and investor awareness campaigns such as Mutual Fund Sahi Hai have started bearing fruits.

Banning upfront commissions will certainly discourage mis-selling and unnecessary portfolio churning, but it might weed out even the genuine small distributors. And that’s a concern.

To grow beyond metros and tier-1 cities mutual fund houses need to reach out to smaller towns and remote places. Mutual fund houses and big distributors aren’t keen to set up their offices in these regions to protect their profitability. Offices in smaller towns initially have higher operational expenses and comparatively nominal revenues. Under such circumstances, smaller distributors and individual mutual fund advisors give them last-mile connectivity.

With the initiation of new norms, the last-mile connectivity strategy is certainly in the red. Small distributors might simply switch to the distribution of insurance products.

Of course, SEBI has been encouraging mutual fund houses to adopt technology and reach out to people. However, what’s crucial is tracking the impact of banning upfront commissions on the popularity of mutual funds given India’s demographics and social structure, awareness about financial products, and effectively low literacy levels. Therefore, investor education would be the key.

Non-tech savvy, retail investors expect personalised services and advice just like high-net investors (HNIs). With falling TER and no upfront commissions, mutual fund distributors will stop catering to small retail investors. Retail investors have played a key role in the phenomenal rise witnessed over a past few years in the AUM of the mutual fund industry.

Now that markets are jittery and upfront commissions are banned, will mutual funds see a major fall in AUM going forward?

Let’s wait and watch for developments closely.

To earn trail commissions, distributors may now discourage investors to redeem units of even underperforming schemes. The probability of their advice being injudicious, skewed towards putting their interest above the investors is high and patient investors are likely to make bad investment decisions. This is its Achilles heel.

The verdict:

It’s evident that the capital market regulator—SEBI (Securities and Exchange Board of India) is on a mission to protect the interest of mutual fund investors.

That said, investors would be better off if they pay for quality advice and invest in direct plans.

The question the regulator and mutual funds should ask mutual fund investors—Are you willing to pay for advice? Fee-based model, where investors are given need-based advice backed by thorough research would be the way forward.

Editor’s Note:

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Happy Investing!

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