That mutual funds are one of the safest ways for retail investors to invest in the stock markets is an oft-repeated line by many investment advisers and even regulatory and government officials.
But, there had always been some concerns raised as well about the costs and the commissions that the fund houses and distributors charged investors.
With the recent set of decisions related to the total expense ratio (TER), the Securities and Exchange Board of India (SEBI) has tried to address both these concerns.
In a nutshell, SEBI has capped the maximum TER at 2.25% for open-ended equity schemes, some of which earlier charged about 2.75%. While it may appear as a marginal reduction, the benefits are expected to be huge as the regulator has also laid down various slabs based on the assets of the scheme with the TER going down as the assets rise.
For instance, if the assets under management (AUM) of a particular scheme is in excess of ₹50,000 crore, then the TER will only be 1.05%. Earlier, any scheme with an AUM of more than ₹300 crore could charge charge 1.75%. So, for large schemes the expense ratio has fallen by almost 70 basis points.
Navin Chandani, chief business development officer, BankBazaar, is of the view that since the quantum of net investment would go up, an investor would be able to accumulate more units in the scheme and the appreciation would be even higher due to the compounding effect.
How it works?
“Let’s assume if your mutual fund investment value is ₹1,000 and your TER is 2.75%, you are paying ₹27.5 as fees during redemption. With 50 basis points reduction to 2.25%, your fees will be reduced to ₹22.5, saving you ₹5. These savings mean a marginally larger part of your money is going to fetch you returns. That is, your investment amount now rises to ₹977.5 from ₹972.5 earlier,” explains Mr. Chandani.
Expense ratio is the share of the fund that is used to meet the administrative, management and other operating expenses of the scheme. According to SEBI estimates, the reduction in TER would lead to investors saving about ₹1,300-1,500 crore in commissions.
“The reduction in the TER would not only lead to greater financial inclusion and helping in attracting more investors, but also would lead to better utilisation of scarce capital resources,” said Karan Marwah, partner and head - capital markets advisory services, KPMG India.
Additional expense ratio
The SEBI has, however, allowed an additional expense ratio of 30 basis points for retail flows from beyond the top 30 cities. This is part of the regulator’s attempts to channelise more household savings from far flung towns into the stock markets through the mutual funds route.
Interestingly, the additional expense will not be allowed for flows from corporates and institutions and will be limited to retail flows thereby making the distributors slog hard to earn the extra commission.
More importantly, the regulator has said that the mutual fund industry should move towards trail model of commission instead of paying upfront commissions to the distributors. Simply put, under trail model, distributors earn a commission only if the investor stays invested for a certain period.
What the capital market regulator has effectively done is that while it has lowered the cost for investors to invest in mutual funds, it has also made sure that distributors do not earn by making investors unnecessarily churn their portfolio.
“As costs go down, the net return of funds increase thereby making mutual funds an even more attractive option for the investor,” said Stefan Groening, director – investment solutions, Sharekhan, BNP Paribas.
“Moving to the all trail model helps better align the distributors interest with the investors, thereby benefitting the retail investor,” said Mr. Groening while adding that this may also make it difficult for new distributors to enter the market.