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Investors in large MFs gain more, hail Sebi move

Sebi’s move to cut the total expense ratio and do away with upfront commissions will reduce costs and instances of mis-selling for MF investors

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In a move that will have wide implications for the Mutual Fund investor, stock market regulator, Securities and Exchange Board of India (Sebi), has reduced the expense ratio of funds across categories, and rationalised commission structure and incentives.

Listed asset management firms like HDFC and Reliance have seen their respective stocks take a hammering on Wednesday. But what do all these moves mean for you - the retail MF investor? Experts tell DNA Money that schemes with large Assets Under Management will now be cheaper for the investor, excessive focus on close-ended funds will reduce and both distributors and fund companies' economic interest will completely align with that of the investor. Read on to know more about the benefits.

Expense account

The expense ratio slabs in MF were introduced in 1996. But, they did not change much even though the industry grew. This meant that expenses borne by an investor did not reduce even though the industry's asset size touched Rs 25 lakh crore.

Now, Sebi has passed on the economies of scale of increasing asset size to investors. To this effect, they have modified the slab-wise limits for TER (Total Expense Ratio) of open-ended funds for equity-oriented funds as well as "other" funds.

"With this move we will see a reduction in TERs of most equity funds, while "other than equity oriented" funds will see limited reduction in TERs, as most funds were already well within the maximum allowable limits," said Kaustubh Belapurkar, director of fund research at Morningstar Investment Adviser India.

The introduction of new slabs with lower TER limits will result in a reduction of overall TER of equity-oriented funds, with assets greater than Rs 2,000 crore. Funds with assets size of less than Rs 2,000 crore will continue to have a similar TER as before. Most equity funds so far were charging the maximum allowable TER as per the erstwhile prescribed slabs. Therefore, with the introduction of new slab wise limits, TERs of most equity funds will reduce, as per Morningstar.

With increasing fund sizes, the quantum of reduction in TER increases. For instance, this move will result in a reduction of 9 bps (basis point) in the TER of a fund with an AUM of Rs 5,000 crore, but a fund with an AUM of Rs 20,000 crore will witness a reduction of TER to the tune of 28 bps. This is exactly what Sebi is trying to achieve, to pass on the economies of scale of larger funds to investors.

Sebi has also modified the slab-wise limits for TERs of other than equity-oriented funds. It is important to note that the majority of these funds charged TERs well within the maximum allowable limits. Thus, the impact of these changes in the slab-wise limits for TER will be limited to only those funds whose TER was closer to the maximum allowable TER as per the erstwhile slab wise limits.

Radhika Gupta, CEO, Edelweiss Asset Management, said: "From an investor point of view, schemes with size will now be cheaper to investors, who enjoy the benefit of scale. That said, cost is not the only reason to choose a scheme - a fund is a total package of which cost is one factor."

Trailblazer

The Sebi has directed the industry to adopt a full trail model in all schemes (except for Systematic Investment Plans), without payment of any upfront commission or upfronting of any trail commission. With this diktat, the upfront commission regime has come to an end. The gap between TERs of direct and regular plans will also reduce, which means regular plan investors pay less. Typically, direct plans are 0.5-0.75% cheaper than regular plans due to absence of distribution expenses, commission, etc.

"Sure, the gap should go down between direct and regular plans. That is an important takeaway. Besides, there is a feeling that commission was being used to nudge investors in a particular direction. So, when the incentive is no longer there, that influence will cease to exist. Recommendations will not be biased by any upfronting. Product selection might become neutral. Also, the propensity to churn portfolios (to get the upfront commission) may go down," said Aashish Somaiyaa, CEO of Motilal Oswal AMC.

Do remember that the new AUM based expense ratio slabs would be applicable for direct plans as well, which should ideally result in a reduction of expense ratios for direct plans too.

So far, close-ended funds have enjoyed the same TER structure as that of open-ended funds. However, Sebi has sharply cut the TER charged on closed-ended funds and capped the same at 1.25% for equity funds and 1% for schemes other than equity funds. Over the last few years, there has been a steady stream of close-ended equity fund launches. Earlier distributors had the incentive to promote closed-ended schemes. Now, they don't. Samant Sikka, Founder, Sqrrl Fintech said, "Capping the TER of closed-ended equity funds at 1.25% will definitely have an impact on the future of closed-ended equity funds making them less attractive for distributors." This, again, will help in bringing down cases of mis-selling.

With regard to the additional expense that can be charged by funds for penetration in B-30 cities, Sebi has stated that this expense can only be charged for inflows from retail investors and not inflows from corporates or institutions. The definition of retail investors would be determined in consultation with the industry.

Gupta of Edelweiss said that from an industry point of view, a focus on trail based income, more transparency in commission structures and correcting the incentives for marketing closed-ended funds is a positive. "Net net, given the opportunity, the industry should focus as an ecosystem on volume growth and expanding the reach of MFs as a product, which will be beneficial to everyone", she added.

LOWER COSTS, HIGHER RETURNS

  • Equity funds will see more reduction in TER than non-equity funds
     
  • A fund with higher AUM will see a bigger fall in its TER than a fund with a lower TER
     
  • Doing away with upfront commission means lower chance of distributor bias for certain schemes/products
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