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New regulations from the Securities and Exchange Board of India, which cap expenses of mutual fund schemes and link them to average assets under management, will impact close-ended schemes the most. These are schemes which come with a pre-specified maturity or lock-in, where investors can subscribe during the period of a new fund offer.
Currently, the distribution industry benefits from close-ended schemes. The mutual fund house, when launching such a scheme, pays a large portion of the total commission applicable during the life of the scheme as upfront commission to a distributor in addition to .
SEBI has now capped the total expense ratio for close-ended funds at 1.25 percent. In addition the regulator has also said that, ‘all commission and expenses, etc. shall necessarily be paid from the scheme only and not from the AMC or its Associate or its sponsor or its Trustee, or any other route.’
This could restrict the ability of an AMC to pay lucrative upfront commissions.
The upfront commission is amortised in the books of the AMCs and recovered from the scheme over its tenure. Close-ended funds were lucrative for distributors as they got commission for three-years upfront, said Kunal Bajaj, founder and CEO of Clearfunds. "It is highly unlikely that the distributors will continue to push these products,” Bajaj added.
Nilesh Shah, Managing Director at Kotak Mahindra Asset Management Company feels this was needed to ensure that a level playing field is created.
“We need to bring parity between various financial products from cost, upfront incentive and commission point of view so that one product with higher cost is not sold to an investor for higher commission or upfront incentive,” Shah said.
To be sure, close-ended schemes do not account for a large share of the assets under management of equity and balanced funds.
Close-ended schemes accounted for 5.5 percent of the total average AUM under equity and balanced funds. According to the Mutual Fund Advisory Committee report submitted to SEBI, there are 173 close-ended schemes that are running currently, with seven schemes that have an average AUM of between Rs 1,000 -5,000 crore.
New close-ended fund offers have dried up, said Vijay Mantri, an independent market expert. “They were very popular with wealth managers and banks because they were interested in upfront commissions. But if you look at Independent Financial Advisors they are more interested in trail commissions,” Mantri said.
Expense Caps: Gainers & Losers
The decision to link the expense ratio to assets under management will also mean a rebalancing between small and large-sized fund houses and different sized funds.
The move will create a level playing field between fund houses, especially those which had a stronger balance sheet, said Shah. According to him, the move by SEBI has ensured that the benefits of economies of scale are passed on to the customers.
On the other hand, smaller schemes may benefit due to a higher permissible total expense ratio.
SEBI’s new norms impose caps on the expense ratios based on the AUMs of these funds. Smaller funds have the highest permissible AUM, which could put larger schemes at a disadvantage.
Mutual fund schemes with larger assets under management will need to bring down expenses more steeply as compared to smaller ones ,said Sunil Subramaniam, MD & CEO at Sundaram Mutual Fund. He expects fresh inflows to come in to smaller schemes as distributors stand to earn more by selling such schemes.
Distributors are expected to push for schemes with AUMs upto Rs 500 crore as expense ratios are higher and commissions that distributors get are likely to be higher.
Total Expense Ratio: The Current Position
The total expense ratio is a combination of management fees charged by the fund house and the commission it pays to the distributor.
The average total expense ratio for equity oriented open-ended mutual fund schemes is more than 2 percent, Bloomberg data showed. However, there has already been a 20 bps reduction a few months back along with an equal reduction due to implementation of GST, according to Mantri.
At the end of financial year 2017-18, 74.4 percent of equity schemes had an average management fee of 1.38 percent, according to data submitted by Mutual Fund Advisory Committee to SEBI. Among balanced schemes, 53 percent had an average management fee of 1.21 percent, the report said.
Watch this discussion for the full implications of SEBI’s decision on expense ratios:
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