For the mutual fund industry, it’s a redux of 2009 when the Securities and Exchange Board of India (Sebi) banned entry load on mutual funds to eliminate upfront charges that investors paid to buy a mutual fund scheme. Sixteen years later, Sebi’s latest consultation paper takes a scalpel to the cost side of the industry to push the ecosystem toward cleaner pricing, clearer disclosure, and thinner margins. That is good for investors but may not be so for the industry. At the heart of the draft is a recalibration of what investors pay and what can be tucked inside the expense ratio.
Sebi proposes removing the long-standing “additional 5 basis points (bps)” add-on; lowering base expense caps—by about 15 bps for open-ended equity schemes and more for certain closed-ended funds; yanking statutory levies (securities transaction tax, goods and services tax, stamp duty, commodities transaction tax) out of the total expense ratio (TER) and making them explicit line items; and slashing brokerage caps from for cash/derivatives.
The implications are huge. First, “headline TER” will finally mean what investors think it means. By taking statutory taxes out of TER but simultaneously requiring a more comprehensive disclosure that totals TER + brokerage/exchange fees + statutory levies, Sebi is nudging the industry toward an “all-in cost” lens rather than marketing-friendly stickers. That should improve like-for-like comparisons across funds and categories, and reduce the chance of double-charging (e.g. research embedded in both advisory fees and brokerage). So there is no doubt that investors will be net winners from lower structural frictions and clearer bills.
Things are, however, hazy on the impact of the proposals on the industry. They will no doubt be a stress test for business models built on opaque pass-throughs. Estimates show some large asset management companies could (AMCs) see almost 30% impact on their earnings. To put these numbers in perspective, a fund house CEO said, “For an industry which has a combined profit of approximately Rs 15,000 crore across 45+ AMCs even after managing Rs 75 lakh crore with 250 million investors, even a 5 bps reduction in TER forms a material proportion of its margins.” While the big fund houses can still take it on their chin, things could get awry if they reduce the payout to distributors. At a time when both Sebi and the industry are working hard to increase the number of investors, a fall in distributors’ income could be counterproductive.
The hardest hit will be brokerages. According to sources in the mutual fund industry, the 80% reduction in charges will lead to a sharp fall in the payout, which is around Rs 1,500-1,800 crore now. Worse still, while most fund houses have in-house research teams, they do count on brokerages for reports and views from analysts. The market regulator’s decision to unbundle costs is similar to what happened in Europe in 2018.
To increase transparency and reduce conflict of interest, the Markets in Financial Instruments Directive II decided to separate costs for investment research from trading commissions. However, the outcome was different. The policy led to a significant reduction in the supply of analyst research, as separate costs for research were too high for some firms to bear. Consequently, three years later, the decision had to be partially reversed as brokerages stopped covering small and medium-sized enterprises with a market capitalisation of less than 1 billion euros. Sebi would perhaps do well to balance the interests of investors as well as the industry.
