Big gains for retail investors in large mutual funds; here is why

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. What does this mean for the retail MF investor? Experts tell DNA Money that both distributors and fund companies’ economic interest will completely align with that of the investor. Read on to know how.

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, the regulator has modified the slab-wise limits for TER (Total Expense Ratio) of open-ended funds for equity-oriented funds as well as “other” funds.

“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.

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. It is only one factor.”

Trailblazer
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 trail commission. 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 costs, commission, etc.

“Sure, the gap should go down between direct and regular plans. 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. Now distributors don’t have the incentive to promote closed-ended schemes. Samant Sikka, Founder, Sqrrl Fintech said, “This 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.

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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.

Source: DNA Money