Mutual funds may find it unviable to run arbitrage schemes, a class of funds under the hybrid category, if the proposals of Sebi on fund expenses become formal guidelines.
The arbitrage fund segment may need to be wound down as MFs will incur losses on them due to the inability to recover transaction costs, according to foreign brokerage Jefferies.
Arbitrage is simultaneous buying and selling the same underlying security or its derivatives in different market segments to make risk-free profits.
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Arbitrage funds buy shares in the cash market and simultaneously sell those in the derivatives market.
Arbitrage funds benefit from equity taxation and have the potential to generate better post-tax returns compared with other short-term debt funds, especially when used to park money. Assets under management of these funds stood at Rs 77,447 crore as of May 31.
“The nature of the product is such that a percentage of the portfolio may require frequent churn, depending on the arbitrage opportunities available in the market. This necessarily adds to the brokerage and STT costs. Under the new rules, these costs will be part of the TER, which will be capped. If the expenses cross this TER limit, the fund will not be able to churn the portfolio,” said the product head of a mid-sized AMC on the condition of anonymity.
Several AMCs have asked the regulator to keep arbitrage funds out of the purview of the recent consultation paper, which proposes to bring brokerage and transaction costs within the TER limit, eliminate double charging of investors and introduce limited-purpose membership for AMCs to execute trades for their own schemes. The aim is to improve accountability, transparency and investor protection in the mutual fund industry.
The introduction of the proposed fee caps for mutual fund schemes may also potentially drive profits of asset management companies down 30% without passing on costs to intermediaries, according to Jefferies. The top-five funds should see around 30-bps fall in TER, the next five a 10-bps fall, the next 10 a 12-bps rise, the next 10 a 4-bps fall and others a 11-bps rise.
“While smaller MFs should gain higher TER, we believe that the risk of disruption exists if larger MFs aggressively advertise their 60-100-bps lower TERs to gain market share in AUMs to offset revenue impact,” the brokerage said.
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Similarly, the impact on profits may vary. The top five fund houses could see a 50% fall in profit, the next five a 17% fall, the next 10 a 37% rise, the next 10 a 28% fall and others a 25% rise. Lower fees for larger funds may also dissuade consolidation or M&A in the sector. In FY22, AMCs reported Rs 10,600 crore in pre-tax profit.
“We believe that AMCs can reduce the impact by sharing the burden with the value-chain that includes distributors, stock brokers and RTA partners, among others. Also, tweaks to caps for arbitrage funds, headroom for STT and balanced TERs could also lower impact,” Jefferies observed.
