Mutual fund investment is all about getting your money handled by a professional fund manager. Market regulator SEBI, therefore, wants to make mutual fund investments a viable proposition for retail investors.
Is your fund house charging unreasonably high fees to manage your portfolio? Don’t worry! In the interest of investors, market regulator SEBI may instruct fund houses to cut down their expense ratio to 5 basis points from the existing 20 basis points. This comes in the backdrop of the existing fee restraints for fund houses. It will be worthwhile to ponder over the motivation behind all these moves.
The equity participation of investors is very low in India as compared to rest of the world. Be it frequent market fluctuations or the high cost of investment, a lot of deterrents still prevail in the economy. SEBI’s move is aimed at making equity mutual fund investments a viable proposition for the retail investors.
Before embarking on SEBI’s ruling, it would be useful to understand the meaning of expense ratio.
Mutual Fund Expense Ratio: Meaning
Mutual fund investment is all about getting your money handled by a professional fund manager. So, managing this portfolio involves various charges which fall under the purview of expense ratio.
The total expense ratio includes fund management fee, registrar fees, distributor commissions and marketing expenses. Expense ratio is expressed as a percentage of fund’s average asset under management.
Every fund house needs to disclose the expense ratio in March and September every year. You are charged expense ratio as an annual fee out of the returns generated by the fund.
SEBI ruling on Expense Ratio
Earlier SEBI had specified limits on the extent of expense fee that mutual funds can charge from the unitholders. It was in the range of 2.25%-2.50% for equity and equity-linked funds.
Within this, SEBI had permitted fund houses to levy a fee of 20 basis points on every scheme. It came at the time when exit loads were removed from mutual funds. Prior to this, mutual fund schemes used to charge an exit load of up to 1% whenever an investor redeemed his mutual fund units. It adversely affected the take home returns of the investor.
So, considering this an an injustice, SEBI had made exit loads redundant which caused fund houses to suffer losses. Hence, in 2012, to compensate fund houses for this loss SEBI had allowed them to include fee of 20 basis points in the total expense ratio.
In the present scenario, SEBI wants to reconsider this charge of 20 basis points and bring it down to 5 basis points. Right now, it is taking up the matter in the Mutual Advisory Committee for further discussion.
In addition to this, SEBI had allowed mutual funds to charge an additional fee of 30 basis point from small town investors; provided the fund house is able to generate business equal to 15% of fund’s average assets. The inflows had to be generated from towns beyond the top 30 cities of India.
Of late the mutual fund industry thinks that none of the fund managers has been able to achieve this target. So, this additional fee of 30 basis points still stands unutilised.
Impact on Investors of SEBI ruling
If accepted, the SEBI’s mandate on reduction of expense ratio would be effective from 1 April 2018.
Investors can take this as a happy news! Their cost of investing is ultimately going to come down. A reduction in investment cost ultimately implies more money in your kitty.
You need to understand that expense ratio has a direct impact on the fund returns. The higher the expense ratio, the lower the take home returns of the investor and vice-versa.
Suppose an equity fund earns a return of 12% and has an expense ratio of 2.25%. So, the net returns after deducting expense ratio would be 9.75%. Hence, it would be better to invest in a consistent performing fund having a low expense ratio rather than investing in an expensive fund which generates high returns.
Additionally, compared to regular plans, direct plans of mutual funds would become all the more cheaper. Direct plans are those which do not have distributor’s involvement in its marketing and thus, don’t entail distributor’s commission in its expense ratio.
So, after SEBI’s mandate comes into effect, it might bring down the total expense ratio by as much as 30-35 basis points. It means your chances of earning better returns are going to be higher.
(By Archit Gupta, Founder & CEO, ClearTax.in)