Recently SEBI’s mutual fund advisory panel recommended raising expenses limit by 25 basis points and is likely to be approved by SEBI chief. At present equity funds are allowed to charge up to 2.50% on first 100 crores, 2.25% on the next 300 crores, 2.00% on the next 300 crores and 1.75% on the balance AUM.. Debt funds are also likewise allowed to charge under the same slab but the charges are lower by 25 basis points for each slab. Now the charges will be increased by 25 basis point for each slab. Let us now try to understand the impact of this decision on mutual fund investment.
First let us go back and understand the major changes effected in mutual fund charges. SEBI banned entry load on equity schemes of mutual fund w.e.f. 1st August’ 2009. The move was brought in together with the option to the investor to decide on payment of commissions to distributors on the basis of quality of advice and service given to him. This has hit the mutual fund industry very badly and the volumes have come down drastically after that. The total strength of the mutual fund distributors has also reduced in the meantime to half, as large number of distributors exited the distribution channel due to insignificant incentives. Investors were also not ready to pay extra fees directly to distributor as it was difficult for them to digest the idea of having to pay an agent by separate cheque. The inventors were fine with the product being loaded with any charge as long as he did not have to shell out any money separately. Banks and corporate distributors benefited the most as the competition reduced. We have just read the news that 63% of the total commission is paid to 25 larger distributors and out of that 12 are leading banks.
After representation from AMFI to compensate distributors, SEBI allowed transaction charge to impose on fresh investment w.e.f. 1st November’ 2011. This has also not helped to improve the sentiment and most of the distributors opted out from the transaction fees. Again new initiatives are initiated after Mr. Manmohan Singh took over the charge of finance ministry. There was a strong representation to bring back the entry load but SEBI has flatly refused to consider the same. One needs to understand the impact of the fee hike compared to entry load allowed previously. It is also important to know that entry load was deducted from the investors fund directly at the time of fresh investment whereas other expenses of mutual fund are deducted at the back end from total investment value. It is not possible for common investor to identify the expenses as the charges are adjusted in the NAV declared.
Let us understand the impact of proposed hike in expense by taking an example. Suppose Mr. Hitesh has investment of Rs. 25 lakhs in mutual fund equity scheme and is also continuing SIP of Rs. 20,000 every month. In the older system when entry load was there, his net investment would have been Rs. 19,600 and Rs. 400 were deducted from him as entry load to be paid to distributor as commission. In that case his yearly outgo would have been Rs. 4,800. Now suppose he continues with same investment and SIP at present then hike in the fees of 25 basis point will cost him Rs. 6,250 yearly and will increase every year with the increase in his investment value. This hike will hit worst to the investors who are heavily invested in mutual fund schemes and also not continuing with any further investment. At present total AUM under equity schemes across all mutual funds is around 1.55 lakh crores and additional 25 basis point means additional charge of 385 crores per annum. Investors will lose these 385 crores yearly only because there is hike in the fees and it has nothing to do with performance of the fund. The under performing funds can still continue without any regulators intervention and still they can increase the charge if approved.
On one hand SEBI claims that it has protected the investor’s interest by banning entry load and on the other hand they are increasing fees which will badly hit investors. One should note that entire exercise is done to help and revive the mutual fund industry and investor protection is nowhere in the mind of the regulator. I fail to understand that the fees are too high in debt funds which hardly give return in double digit. Therefore most of the people prefer traditional investment like PPF, Postal schemes and Bank FDs for their part of debt investment. These investments not only offer fixed return but are also not subject to market risk. SEBI, AMFI and AMCs must come out with the suitable alternative investor friendly solution. It is not advisable to keep out IFAs from the distribution channel to benefit big players. Bailing out package will not serve the purpose unless investor’s interest is protected.