Lately, SEBI has issued a Consultation Paper for reviewing TER (Total Expense Ratio) charged by AMCs (Asset Management Companies) to unitholders of schemes of Mutual Funds. The aim is to facilitate greater transparency and accrual of benefits of economies of scale to investors.
The
basic objective of Mutual Funds is to extend the benefits of expertise in
investments to common public specifically to those who don't have large capital
to invest and who don't have adequate knowledge of the working of financial
instruments. These Mutual Funds are usually managed by AMCs who take the
money from the investors by selling Mutual Fund units and invest them in
different equity or debt instruments and then hand over the major chunk of
profit generated by this to unitholders. As this requires significant
application of expertise they charge their fees in form of Expense Ratio over
and above Entry Load (now not charged in India), Exit Load and Transaction
Charges.
For
saving the usually less aware investors (unitholders) from the whimsical
amounts in the name of charges of AMCs, SEBI has put a cap on the Expense Ratio
since long. But even in this framework some of the expenses have been kept
aloof from this capping clause so far. Such charges are -
i.
Brokerage and transaction costs (up to 0.12% for cash and 0.05% for
derivatives)
ii.
Expenses not exceeding 0.30% of daily net assets subject to net inflows from
B-30 cities
iii.
Additional expenses not exceeding 0.05% of daily net assets for the schemes
having Exit Load
iv.
GST and advisory fees
It is
worthy to mention here that there is no upper cap on additional expenses as a
whole.
But the Mutual Fund industry has grown significantly over the last few years with
considerable increase in participation of retail investors. Hence the concerns
existing at the time of introduction of additional expenses over and above the
TER may not hold true today keeping in views of economies of scale. Moreover,
since there is ambiguity and lack of transparency in the manner in which
unitholders are charged by different Mutual Funds. In the view of SEBI, it is
desirable that TER reflects the maximum expense ratio that an investor may have
to pay and hence it should be inclusive of all the expenses permitted to be
charged to an investor and investor should not be charged any amount over
and above the prescribed TER limits. And the recent Consultation paper of SEBI
has proposed to implement the same.
As in the
extant provisions, AMCs are already allowed to become a proprietary trading
member for carrying out trades in the debt segment of the recognised stock
exchange on behalf of its mutual fund schemes and are also permitted to become
a self-clearing member of the recognised clearing corporations to clear and
settle trades in the debt segment on behalf of its mutual fund schemes. As SEBI
intends to bring the brokerage and transaction cost within the TER limits (and not charged over and above it as of now) there is a likelihood that this may reduce some profit of AMCs for increasing the profit of
unitholders. So something must be done to lessen the expenses of AMCs too. This
is proposed to be done by allowing them to exercise their option of obtaining
limited purpose membership with stock exchanges for carrying out trades in both
debt and equity segments. This step will help them to reduce expenses towards
brokerage and transaction cost. As this step is a win-win for both AMCs and
unitholders so undoubtedly a welcome step.
For
promoting inclusiveness of Mutual Fund schemes it is desirable that there
should be more incentives to the distributors working in smaller cities namely
B-30 cities i.e. cities other than the top 30 cities in India. Though it looks
a benign provision which actually serves the motive of addressing the right of
equality in financial investment of comparatively interior areas of India, the
problem arises when it is misused. Investment amounts higher than INR 2 lakhs
(threshold for classification as retail investment) are often split to make
each application for investment of less than INR 2 lakh so that B-30 expenses
can be charged. Also in many cases, investments of B-30 investors are often
churned by way of withdrawal and re-investment after a year (One year is the
minimum holding period requirement). Moreover the varying methods of computing
additional expenses for inflows from B-30 cities and charging of expenses based
on projections rather than actuals add to lot of confusion. So, if the
distributors are paid B-30 expenses for investments from only the new
individuals (PAN) added as proposed then it must reduce the malpractice of
churning by way of withdrawal and re-investment every year just to avail the
expense benefit. Also, the proposal of charging of expenses on actuals and not
on projected figures is well-appreciated. The additional commission is proposed
to be fixed at 1% subject to a maximum of INR 2000/-.
Exit
Load is allowed to AMCs in case of early redemption by investors. The intent
behind the said amendment was that early redemptions by investors from the
scheme has impact on the non-exiting investors and thus they should be
compensated by crediting exit load to the scheme. AMCs can presently charge
additional 5 bps (basis points) i.e. .05% of daily net assets due to credit of
any exit load to the scheme. The said additional charge was allowed for schemes
where SIDs (Scheme Information Document) have a provision of charging of exit
load. But here SEBI found that AMCs can charge additional 5 bps to
the scheme even if there is no claw back/ exit load credited to the scheme. So,
it has proposed that this additional expense of 5 bps should be discontinued.
Some people say, rather than discontinuing it, this expense should be allowed
on the actual amount of exit load charged and credited to the schemes. By this,
they think, the purpose of safeguarding the interest of non-exiting investors
would be served more accurately.
GST
(Goods and Service Tax) on investment and advisory fees is presently charged
over and above the specified TER limits which is proposed to be brought under
the new TER limit which will be fixed after a suitable adjustment for removing
a probable significant impact for change in this provision. Here, it is not
clear why the matter is being complicated if SEBI has no objection in allowing
GST on investment and advisory fees over and above the present TER limit.
As per
the extant provision, a slab wise TER structure in the MF Regulations has been
specified for passing of the benefit of economies of scale achieved by AMCs. It
means, higher the AUM size, lesser the limit of TER. The proposal is that TER
slabs should be at the level of the AMCs and not at the scheme level. The
reason behind this is to avoid switch transactions from existing large AUM
schemes to NFO schemes of the same AMC where higher TER can be charged. The
bucketing of Equity based AUM and and other than equity based AUM of the AMC is
likely to be useful considering the skill set required for analysing and taking
decision of investments for equity & equity related products is different
from the skill sets required for other than equity related products.
Revision
of TER limits is a core proposal of this consultation paper and all the
expenses will have to be brought under this TER limit in the new regime. This is
vital to revise it adequately so that AMCs should not feel discouraged for
applying their best mind and efforts in favour of maximum return to the
unitholders. The four additional expenses allowed at present over and above the
TER till now will come under the overall limit of revised TER. These expenses
are (i) Brokerage and transaction costs which is 0.12% of cash trade and 0.05%
of derivative transactions, (ii) Expenses not exceeding 0.30% if daily net
assets subject to the inflows from B-30 cities, (iii) Additional expenses not
exceeding 0.05% of daily net assets for the schemes having provision of exit
load and (iv) GST on investment and advisory fees charged by Mutual Funds/
AMCs.
All of
the above expenses will be just a part of overall TER limit after the
implementation of new provisions. If the new slabs from 2.5% to 1.3% (for
equity oriented instruments) and 1.2% to 0.9% (for other than equity related
instruments) had been implemented in FY 2021-22 then the expenses charged had
been fallen down from INR 30,806 crores to 29,404 crore lessening the impact by
4.55% at industry level.
Though
the weighted average method for hybrid schemes and glide path for AMCs seem to
be fine the overall limit of TER may better be fixed after taking the AMCs in
confidence since the ultimate return depends on their efficient working and not
on regulatory limits on expenses they incur. This is particularly significant
in equity oriented schemes.
Other
proposal includes disallowance of upfront commission by investor directly to
distributors and transaction costs deductible from investments of investors which seems well.
International
funds with large AUM have a low cost structure and thus Indian AMCs are often
left with less room to charge desired TER for managing investments in such
international FOFs. Futher, AMCs are also required to pay licensing fees for
using an overseas benchmark. Thus, for avoiding relatively high-cost
international funds being sold to Indian investors instead of low cost
efficient funds which is not in the best interests of investors it is proposed
that the TER shall not exceed higher of two times the weighted average of the
TER levied and the actual cost of running a scheme including distribution
commission.
To
discourage churning / mis-selling by distributors it is proposed that the
distributor shall be entitled to lower of the commissions offered under the two
schemes of any switch transaction which is fine. The lowering of maximum
permissible limit of exit load from 5% to 2% is also proposed. As this will
fall under presumably under the overall limit of the new TER any overthinking
on it seems futile.
Performance
based TER is also being explored and to start with, performance linked TER can
be enabled for active open ended equity schemes wherein AMCs can charge higher
management fees if the scheme performance is more than an indicative return
above the tracking difference adjusted benchmark. Tracking difference adjusted
benchmark means benchmark returns adjusted for permissible operational cost of
managing the fund. Alternatively, AMC can be permitted to charge higher
management fee based on a pre-decided hurdle rate. The maximum management fees
may also be specified to discourage fund managers from taking imprudent risk in
order to earn higher fees. Though it has been asked by SEBI whether to make performance
based TER mandatory or voluntary, the more effective way seems to be making it
voluntary. Even though they opt for higher TER based upon their performance the
upper cap as mentioned above will save investors from reckless risk-taking
propensity.
Additional
incentive for inclusion of women investors in Mutual Funds is a welcome step.
The grandfathering clause (a provision in which an old rule continues to apply
to some existing situations while a new rule will apply to all future cases)
seems to be well-intentioned to safeguard the existing investors in ELSS
(Equity Linked Saving Schemes), Close Ended schemes and Target Maturity scheme.
Yes, it would be just to investors to exit without exit load (as proposed) in
case the TER limit is going to increase in their case.
Regular
plan and Direct plan are virtually the same after they are bought the only
difference being at the time of buying the distribution commission is charged
to the investors in case of Regular plan. Therefore, it is but logical that
there should be uniformity in charging of each and every expense to the
investor of regular plan and direct plan (other than distribution commission).
Putting
all the points succinctly it can be said that the proposals mentioned in the
consultation paper of SEBI are well-intentioned and seem pragmatic. Though at
the same time the ultimate aim should be to ensure enhanced profitability of
the working of AMCs by way of tight monitoring and inspection. Needless to mention that even
lessening chargeable expenses will have no meaning if AMCs don’t apply their
best efforts for ensuring the best returns possible.
….
Author- D Hemant Kumar
Email- hemantdas2001@gmail.com
Disclaimer: The author is not a Mutual Fund expert and the views expressed in this article is based on his personal understanding and perception over the consultation paper issued by SEBI.
