The Securities and Exchange Board of India’s (Sebi’s) decision to introduce a uniform total expense ratio (TER) takes forward its move to reduce costs for investors and curb mis-selling in the Rs 40-trillion mutual fund industry. The initiatives seek to ensure that investors are not burdened with hidden or additional expenses. Presently, the market regulator allows asset management companies (AMCs) to levy four types of supplementary expenses beyond the specified TER limits. These include brokerage fees, transaction costs, distribution commission for inflows from B-30 cities, goods and services taxes (GST), as well as exit load-related charges. Under the new proposal, all permissible expenses will be incorporated within the maximum allowable total expense ratio. Brokerage and transaction fees will fall under this limit, along with securities transaction tax (STT).
In its 40-page consultation paper issued late Thursday night, Sebi states that TER reflects the maximum expense ratio an investor may have to pay and hence should be inclusive of all expenses permitted to be charged to an investor. Further, it has recommended continuing distributor commissions for inflows from B-30 cities, but only for new individual investors with unique PAN numbers registered at industry levels. This step is crucial, as there have been allegations of distributors shifting investors from one scheme to another to earn higher commissions. For instance, it is widely known that some distributors mis-sell new fund offers to existing investors by falsely claiming it to be cheaper, given that the net asset value (NAV) of new schemes is `10 compared to an existing scheme with an NAV of, let’s say, Rs 50. Among other proposals, Sebi proposed to lower the exit load of an open-ended scheme to a maximum permissible limit of 2%.
The suggestion of revised TER slabs will ensure that small players are not disadvantaged, and will lead to competition among AMCs of all sizes since around 20% of the companies currently manage around 75% of the industry’s assets under management (AUM) and many small AMCs continue to operate at a loss. However, some believe that distributors might be encouraged to promote schemes of smaller fund houses without a long-term track record. Industry observers say that there could be some other pain points also. For example, subsuming the brokerage cost with TER. Sebi’s argument that fund houses should have their own research teams instead of paying higher brokerage for research reports is on a weak footing. It is quite difficult and expensive for fund houses to set up their own research teams that will provide the best stock analyses across sectors. There are many brokerages which specialise in certain sectors. To replicate such a model in-house will be a complicated job. In fact, even globally, fund managers are allowed to access third-party research.
No wonder, initial research reports indicate that the overall impact on the industry is estimated to be around Rs 1,400 crore. Calculations by Jefferies show that this would result in a 5% increase in costs and a 13% decrease in pre-tax profit. Share prices of some of the AMCs also took a hit on Friday. While Sebi’s intentions seem fair, at least on paper, it is important that the regulator takes into account the fact that the industry is still largely distributor-driven. By making it increasingly difficult for distributors to rely on the sale of mutual funds as their sole income, life could become quite difficult for many.