The Telegraph
Monday , August 20 , 2012
Since 1st March, 1999
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Going gets tough

Investments in mutual funds can get costlier by more than 20 per cent with market cop Sebi deciding to bring in some sweeping regulatory changes to breathe fire into the industry plagued with a depleting investor base.

During the current financial year till July, fund houses lost nearly 10.5 lakh accounts from their equity schemes (including ELSS) — that is, 8,600 folios a day! The number of folios lost (in equity/growth schemes) between April 2010 and July this year is more than 45 lakh.

What intensifies the problem is the concentration of mutual fund investors in the top 15 cities of the country.

According to a Crisil research report (in December 2011), top five cities of the country contribute 75 per cent of the total assets under management of fund houses and the next 10 cities account for another 13 per cent.

Quick energisers

Last week, taking cognisance of the lack of penetration of mutual funds products and the need to realign the interests of investors, distributors and fund houses, Sebi decided to take some immediate steps.

Let us first list the important measures that will materially affect your returns from mutual fund investments.

● Expenses for fund houses have been made fungible to give them greater flexibility to tailor their revenue use for business needs.

● Mutual fund investors will now have to pay service tax on fund management fees.

● Fund houses are allowed to charge an additional expense up to 0.20 per cent of the assets under management (AUM) of respective schemes.

● Entire collection from exit load, if any, has to be written back to the scheme’s AUM.

● Fund houses can charge an additional expense (up to 0.30 per cent of AUM) depending on the extent of new inflows from locations beyond the top 15 cities. Fund houses can charge 0.30 per cent if the new inflows from these cities/ towns are a minimum 30 per cent of total inflows. In the case of lesser inflows, the additional expense ratio will be on proportionate basis.

● Fund houses will have to come up with a separate plan under the same scheme for investors who invest directly with the fund house. These plans will have lower expense ratios than those brought through distributors or agents.

● Mutual funds will now be able to accept investments in cash up to Rs 20,000 from investors.

Higher expense ratio

At present, equity mutual fund schemes with an AUM of Rs 100 crore or less can charge a maximum of 2.5 per cent as expense ratio every year. The maximum expense ratio for the next Rs 300 crore asset under management is 2.25 per cent. It is 2 per cent for the next Rs 300 crore and 1.75 per cent beyond that.

Thus, if you have invested in an equity scheme with an AUM of Rs 500 crore, the maximum total expense that the fund house can charge every year is 2.4 per cent of the AUM. Of this 2.4 per cent, 1.25 per cent will go towards fund management and advisory fees and the rest include expenses towards distributors’ trail commission, marketing, operational cost, brokerage and custodian fees and so on.

At present, there are sub-limits on all these expenses.

Now, with the fungibility in place, there will be no sub-limits and fund houses can use the money on whatever they think is beneficial for their business. And, it is quite possible that fund houses will jack up their fund management fees while reducing other expenses.

Besides, fund managers are now allowed to charge an additional 0.20 per cent expense across schemes. So, the maximum total expense ratio of the scheme in which you have invested will now be 2.60 per cent even if fund houses do not go beyond the top 15 cities. Fund houses can divide this hike between their fund management charges and the trail commission for distributors.

So, after the implementation of the new regulations, the fund management fees of mutual fund schemes are likely to go up along with the total expense ratio.

Now that mutual fund investors will have to pay the service tax, it will mean an addition of 15-17 basis points to the increased expense ratio of 2.80 per cent.

The total expense ratio will, thus, go up by nearly 17 per cent.

Among the 44 mutual funds in the country, the top 5 fund houses account for 56 per cent of the total AUM and the top 10 houses control 80 per cent of the Rs 7.3 lakh crore assets.

Most of these fund houses have presence beyond the top 15 cities through their own distribution network, bancassurance and other corporate tie-ups. They can slap additional expenses over and above what have been discussed above depending on how much investment they can mobilise beyond the top 15 cities.

So, the total expense ratio of your scheme can go up to 2.90 or even 3 per cent — that is, 20 per cent or more.

Sebi, however, has contended that the 20-basis-point increase in the total expense ratio will not result in any additional cost increase for investors because fund houses are now required to write back the entire exit load to the scheme’s AUM.

Investors in any particular scheme will not be affected by the increase in expense ratio by 20 basis points if and only if more than 20 per cent investors in the scheme exit before one year of investment. Otherwise, the cost will increase.

The impact of this increased cost for mutual fund investments can be as much as 10 to 15 per cent less return if you remain invested for a sufficiently long period, say 15 years, in an equity scheme.

For debt schemes, the impact will be much more because equity schemes generally give a very high return if one remains invested for a long period of time. The return rate for debt schemes in comparison is much less. Even a 10-15 per cent increase in cost will certainly make debt mutual fund schemes unattractive despite the tax benefits.

However, if you directly go to the offices of fund houses and invest without the mediation of any agent or distributor (including banks), you stand to gain.

Fund houses will now have to offer a separate plan with a low expense ratio for investors who directly come to them.

As investment in mutual funds becomes costlier would you go for unit-linked insurance plans (Ulips)? Watch out for cost structures of the two instruments and compare the returns.