Its wake-up time for funds as serious money flows in

Updated: Mar 29 2006, 05:30am hrs
How would you react if you found out that in many new mutual fund issues that claim to be without any load, the fund company actually charges you a large part of the expenses that it incurs while marketing the issue Not only that, they also charge you this money by deducting it gradually over many years and the money that should be charged from investors who happen to disinvest from the fund is actually charged from investors who stay back!

There have been funds where these charges have been as high as 4% or 5%. And not only that: there appear to have been funds where so many investors have left that the effective charge paid by some investors may have been as high as 10%.

There will soon be a law that fund companies must pay their own expenses or they must explicitly charge a load from investors upfront. The current practice, of maintaining a facade of there being no load and actually charging the money later, must stop.

Lets get a little clarity about what these expenses are and why they are charged. Asset management companies (AMCs) have funds that are their own, in the sense that this is money invested by the AMCs owners or money otherwise earned as profit by the AMC. Bringing out a new fund issue is an expensive business. Advertising is expensive and getting people to buy your fund means spending a lot of money. And, advertising is not the only big expense. For most funds, the commission that has to be paid to distributors and salesmen, who actually come and pitch the fund, is the biggest cost.

These expenses can be paid by the AMC itself or can be charged to the funds investors. If it is to be charged to investors, then it can either be charged upfront as load or gradually over a long period. The route that some AMCs take which, to my mind is clearly unethical, is to create a no-load buzz upfront and then keep charging the money over the next five years.

The basic principles are very clearfund companies must confess exactly how much money they are charging investors and they must not create grossly unfair rules that allow them to take one lot of investors money from another.

However, so self-evident are these principles and so deeply are they linked to the basic ethics of running a mutual fund, that it is more than a little disturbing that these practices will stop only after Sebi has brought a rule to stop these.

The fund companies that are still behaving this way will, no doubt, tell you that this is a universal practice. But, it actually isnt. The fact is that some fund companies have never done this and others have stopped voluntarily without waiting for Sebi to crack the whip.

The real issue that gets highlighted here is not arcane accounting details of how funds are run. But, the broader one of the intensity with which mutual funds need to be regulated in this country.

People are finally entrusting Indian mutual funds with serious sums of money to invest. And if some AMCs insist on sticking only to the barest minimum letter and not the spirit of the law, then the fund industry will do damage to the bright future that it surely has in this country.

The writer is CEO, Value Research