Mumbai: The Securities and Exchange Board of India (Sebi) is pushing mutual funds to merge common investment plans and cut high expenses charged to investors.
The markets regulator proposes to introduce rules to that effect as part of the next set of reforms after 2012, when it allowed investors to buy directly from fund houses and save on broker commissions, and removed internal sub-limits within the expense ratio.
Expense ratio is the percentage of assets spent to run a mutual fund. A lower expense ratio bodes well for investors. Removing internal sub-limits allowed fund houses more flexibility in deciding how they wanted to spend the money they received from investors towards the expense ratio.
Forty-two asset management companies in India cumulatively manage nearly Rs20 trillion spread across 2,000 schemes, which, according to the regulator, is disproportionately high.
“Sebi had been asking the industry to merge the schemes for the past three years but the same did not happen. After the nomenclature comes in the fund houses would not have a choice but to merge the schemes,” said Jimmy Patel, chief executive officer, Quantum Mutual Fund.
Sebi is looking to ease a merger of mutual fund schemes by sorting them under categories such as debt, equity or hybrid funds.
“The regulator has been asking the industry to consolidate its schemes but the industry is yet to take steps in that direction. A balanced fund should be truly balanced in nature, we don’t want investors to regret later that they went by nomenclature and the fund wasn’t balanced at all,” G. Mahalingam, a whole-time member at the capital markets regulator, said on Wednesday at an event hosted by industry lobby Ficci. “If a fund is dealing in debt, then it should be called a debt fund.”
Currently, Sebi nomenclature rules for mutual funds loosely define just two aspects—whether a fund is open-ended or close-ended and whether it invests in equity or debt. “A clearer definition would prevent duplication of funds of similar nature and help investors make informed decision,” said Manoj Nagpal, managing director and chief executive officer, Outlook Asia Capital, a Mumbai-based mutual fund advisory firm.
According to Sebi’s Mahalingam, mutual funds should cut their expense ratio as assets are growing at a fast pace. “This is a good time for the industry to shrink its profits, bring in more investors into their fold,” said Mahalingam.
Under existing norms, the maximum expense that an equity scheme can charge to an investor is 2.5% of assets managed; this is 2.25% for debt funds. The rate is applicable in slabs and a fund house is allowed to charge 2.5% for the first Rs100 crore in weekly average net assets of a scheme. For the next Rs300 crore, a total expense ratio of 2.25% can be charged. For anything beyond that, fund houses can charge an expense ratio of 1.75%.
According to a 2016 report by investment research firm Morningstar, the total expense ratio in most countries is between 1% and 1.7%, with India and Canada the most expensive at over 2%.
According to Nagpal, the expense ratio is higher because mutual funds use the leeway available to them to charge more. Current norms allow funds to charge 20 basis points (of assets managed) instead of charging an exit fee and another 30 basis points as expense for promoting mutual funds to investors from smaller towns. A basis point is one-hundredth of a percentage point.
“The 20 basis points is supposed to be compensatory in nature but data suggests something else. As of 2016, the 20 basis points allowed to be charged in lieu of the exit load helped fund houses earn Rs350 crore; only Rs75-80 crore was credited back to the scheme. In addition, the 30 basis points allowed for penetration is charged to the entire assets under management, when it should be limited to only assets coming from” smaller cities, said Nagpal.
Sebi is also asking mutual funds to benchmark their schemes against the Total Return Index (TRI), a benchmark that captures dividend income.
This, according to Mahalingam, will give distributors and investors a truer picture of the fund performance with respect to the benchmark. Unlike traditional benchmarks which do not account for dividend income, TRI includes interest, capital gains and dividends realized over a period of time. Currently, only DSP BlackRock Mutual Fund and Edelweiss Mutual Fund benchmark their schemes to TRI.