Sebi may up expense ratio for revival of MF industry

Written by Sunny Verma | New Delhi | Updated: Jul 2 2012, 06:07am hrs
The Securities and Exchange Board of India (Sebi) is unlikely to restore entry loads on mutual funds but may increase the expenses charged by fund houses instead. This move is expected to make the mutual funds business viable, without having to suffer the side-effects of bringing back entry loads.

Entry loads typically create an incentive for the distributors to encourage early churning of the folios held by the clients. Since loads are charged every time a customer buys units of a fresh mutual fund, distributors and agents have an incentive to promote early exits by clients from existing funds. Sebi is, therefore, not in favour of bringing entry loads back, a senior government official who interacts with the regulator said.

After Prime Minister Manmohan Singh took charge of the finance portfolio, he talked about issues concerning the financial sector, including the mutual fund industry and the insurance sector, and said that these issues need to be resolved.

Mutual funds are allowed to charge various maintenance expenses annually, and the overall expense ratio is capped at 2.25% of assets under management (AUM). Increasing the expense ratio to 2.5% of AUM per annum would result in mutual funds annual income increasing by as much as 11%.

On an AUM base of R2.5 lakh crore, a 2.5% expense ratio would yield an income of R6,225 crore a year, up from R5,625 crore a year at 2.25% currently. This extra income of R625 crore per annum would provide a fillip to the mutual fund industry, enabling them to pay more to distributors. Mutual funds had aggregate AUM of R7 lakh crore as on May 31 in all schemes, according to Association of Mutual Funds in India (AMFI) data.

A higher expense ratio would mean that Sebi may not be required to reintroduce entry loads, which were banned in 2009 to protect investors interests.

This ban coincided with the drying up of fresh inflows into mutual funds in the past three years. The mutual fund industry saw a net inflow of only Rs 122 crore in 2011-12, while there was an exodus of Rs 13,139 crore in 2010-11, as per AMFI data.

Restoring entry loads on mutual funds may not help much as inflows came to a halt largely due to poor market conditions, which discouraged investors, said Dhirendra Kumar, CEO, Value Research. Increasing the limit on the expense ratio and permitting mutual funds to float pension funds with tax breaks similar to those available under the National Pension Scheme would definitely help the entire mutual funds industry, Kumar said.

The finance ministry and Sebi are expected to discuss various measures this week in order to finalise the plan to reinvigorate the mutual fund industry. The Prime Minister said last week that there were issues in the mutual fund industry that needed to be resolved. Kumar said Sebi should try to encourage long-term investment in the equity market and create disincentives for short-term behaviour both by distributors and unit holders.