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Suresh Krishnamurthy

LARGE expense charges that drag down returns from mutual fund income schemes are a sensitive issue for the fund industry — one that the players want resolved to the best interest of all concerned. However, the problem cannot be resolved if the asset management companies themselves are not willing to make some sacrifices.

High brokerage and recalcitrant brokers are not the only factors behind the large charges to mutual fund income schemes. Management expenses, too, are high. A reduction in both brokerage and management fees appear to be in order. Else, the problem can, over the next six months, morph into a crisis of sorts. One can only hope for a solution before it does.

High management fees: The financial statements of six large income fund managing companies — Alliance, Birla, Templeton, HDFC, Prudential and Grindlays — indicate that management expenses are as high as 50 per cent of the total recurring expenses. The average management fees charged work out to about 0.8 per cent of average net assets.

Is it fair consideration of the services rendered? Maybe.

Can it come down? It can. Consider the long-term gilt plans of these large mutual funds. The management fees charged in the case of the gilt plans is about 0.7 per cent. In Alliance, Birla, Templeton and Prudential ICICI, the management expenses charged to gilt funds are significantly lower than that charged to the bond funds (see Table).

In addition, the management expenses charged to institutional plans are even lower than those charged to gilt plans. Clearly, the lower expense ratios of Gilt Plans and Institutional Plans are partly because of lower management fees charged to these schemes.

It is not merely because of the absence of brokerage in these plans. This suggests that the scope does exist for a reduction in management fees charged to retail plans of mutual fund income schemes.

The question is whether asset management companies can make profits if they cut down on management fees charged. However, if they do not cut down, mutual fund income schemes may no longer be a sensible option for retail investors.

Rein in brokers: On its part, SEBI needs to bring the brokers around. Brokerage charged to an income scheme appears to be as high as management fees charged. This is a travesty. Brokers may be performing a valuable function in bringing together asset management companies and their customers. However, it can never be equated with the fund manager's attempt to create value.

Importantly, from an investor's perspective, the value provided by the broking community is open to question. There are allegations that broking firms do not try to sell what is suitable to an investor but what is suitable to their own bottomlines.

In any case, the broking industry is still to provide wealth management services of any significance. The distribution network of the broking industry remains their one and only selling point. In addition, if it does provide valuable services to investors, it would be better to claim compensation from particular investors. Claims for large brokerages that will be debited to mutual fund income schemes are unjustified. It is in their own interest to reduce the brokerage that they demand from mutual funds. In any case, it is time a solution was found to the problem of expenses charged to mutual fund income schemes. For investors, possible returns from mutual fund income schemes are 1.5 to 2 times the returns possible in the US market.

Expense charges, though, are 5-6 times what are charged in the US. Indeed, US funds are several times larger. However, if expenses are not lowered, Indian funds may never grow in size, as investor patronage will only dwindle.

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