Mutual benefit

Updated: Mar 23 2006, 05:30am hrs
The Securities and Exchange Board of Indias (Sebi) seems set to revise its norms on initial expenses of mutual funds (MFs). This is welcome news. Under the existing guidelines, fund houses are allowed to charge up to 6% of their collections during new fund offers as issue expenses and amortise the amount over five years. The result is that long-term investors, who stay invested with the scheme, bear the brunt of the initial expenses even as short-term investors get more favourable treatment. This goes against the very logic of MFs, which is to promote genuine long-term investors.

With MFs getting more and more ambitious in their pre-issue advertising blitz and rising distribution and brokerage charges, issue expenses have been mounting. Meanwhile, aggressive selling by distributors has resulted in much higher churn in the subscriber base of MFs, with investors entering and exiting with far greater frequency. According to the Churning Report of a leading MF registrar, 50% of all equity and balanced fund purchases brokered by the top 20 distributors during 2004-05 were redeemed within a year. Inevitably, the number of long-term investors remaining in each scheme has been declining, even as the burden of pre-issue expenses on them has increased proportionately.

As the apex industry body, AMFI is understandably concerned that if this trend continues, MFs as a concept will fall out of favour with genuine long-term investors. Long term, this is bound to affect the growth of the MF industry. The first signs are already there. Though total inflow into MFs in 2004-05 was Rs 8,39,662 crore, of which new funds raised a record Rs 25,000 crore, the net growth was just Rs 2,154 crore, lowest in the past five years. What makes matters worse is that there is no transparency in how the net asset value of a scheme is calculated. Thus, the AMC may declare an above par NAV soon after the issue closes, but the investor may not be aware that the fund would write off issue expenses, resulting in a fall in the NAV. Clearly, it is time Sebi acted and ensured a healthy growth of the MF industry.