The Mutual Fund Advisory Committee met with SEBI to bring some kind of equilibrium between the interests of investors and that of distributors, with a hope to channel growth of the Industry.
Following the meeting, SEBI has proposed a slew of measures (pending notification) to increase the participation of retail investors in the mutual fund industry. Here, we take a look at some important proposals and, if implemented, their impact on you as a mutual fund investor.
Fungibility
At present, equity mutual funds can charge a maximum up to 2.5 per cent as expense ratio (expense ratio refers to a measure of costs debited by the asset management companies (AMCs) for operating a scheme). Mutual funds had to allocate a maximum of 1.25 per cent as fund management fee/charge, and 1.25 per cent as other expenses incurred by the AMC for marketing, distribution, operations and so on. Any expenses above 2.5 per cent are to be borne by the AMC.
SEBI has now proposed to remove the sub-limits on expenses, giving AMCs the freedom to allocate the 2.5 per cent expense ratio the way they want to.
This fungibility will give fund houses full flexibility to use Total Expense Ratio (TER) the way they want. But this may lead to a compromise on transparency and disclosures since detailed disclosures of costs incurred other than management fee will not be given.
According to the new proposal, AMCs are further allowed to charge additional TER up to 30 basis points, if 30 per cent of their net sales take place beyond the top 15 cities depending upon the extent of new inflows from locations beyond top 15 cities (claw back of additional TER if the investments are redeemed within a period of one year).
This means that the total expense ratios for any money coming from other than the top 15 cities can be hiked to 2.8 per cent instead of 2.5 per cent for equity schemes, which will thus reduce investor’s capital returns.
We believe that it is important for the mutual fund industry to improve its geographical reach and bring in long-term retail money from smaller towns.
But like any other businesses, it should have been the AMC who bears the expansion cost rather than the investor. Moreover, unnecessary branch opening by the AMCs in the race to garner assets (as has been evidenced in the past) may eventually lead to mis-selling of the schemes.
Small investor
In order to enhance the reach of mutual fund products and increase financial inclusion, cash investment up to Rs 20,000 will be allowed, subject to compliances. These investors can now get the benefit of professional investment management provided by the fund houses.
However, the facility may lead to money laundering as well as increase in the operational cost and the hassle of bringing that money from tier-2 or tier-3 cities to the fund house in Mumbai, where eventually it will get invested. Redemptions of such amounts may also pose a challenge.
Further, in a move to encourage long-term holding, all AMCs would also have to now plough back their entire exit loads into the scheme during redemption (they will be able to charge an additional TER to the extent of 20 bps).
Currently, of the total exit loads collected during redemption, 1 per cent is used to pay for marketing and selling expenses of the scheme and any exit loads collected beyond 1 per cent is ploughed back into the scheme. This move by SEBI, of drawing exit loads back into the scheme, is welcome.
Today, service tax on the management fee is included in the TER. To enable the mutual fund industry to be in line with all other industries, where service tax (12.36 per cent) is borne by the end-user, SEBI has decided that the service tax payable on investment management fees should be charged to the scheme and be borne by investors.
NAV
To strengthen the regulatory framework for mutual funds, SEBI has stated that AMCs are to make monthly portfolio disclosures on their web site.
Further, to ensure fair treatment to existing investors of schemes, SEBI has decided to harmonise applicability of NAV across various schemes based on the day on which the funds are available for utilisation, for an amount equal to or more than Rs 2 lakh.
To promote direct investment and to pass on the benefit of lower ‘procurement’ cost to the investor, SEBI has mooted the idea of a different plan for direct investors in a mutual scheme with lower expense ratio. It will help investors to save the additional cost they pay for the distributor’s services; it will also not be operationally difficult for fund houses to manage this. The real challenge here is how the AMCs will deal with a distributor in case a customer introduced by him makes additional investment into the direct plan.
While confronting the issue of mis-selling, monitoring would be done through an evolved system of ‘product labelling’. Product labelling basically means creating a categorisation system that helps investors make sense of the large number and variety of funds that are available.
This system will bring uniformity in fund categorisation, which will help tackle the issue of mis-selling. The investor will have a better understanding of the scheme that he proposes to invest in, while also tracking peers’. SEBI has also directed mutual funds to set apart a portion of the asset management fees annually for investor education campaign, ensuring greater focus on this issue.
SEBI’s recommendation of mutual fund investments being a part of the Rajiv Gandhi Equity Savings Scheme could assist AMCs in attracting new investors in capital markets.
The Regulator has also introduced different levels of certification and registration for distributors that would be required depending upon the products and services offered.
SEBI has also proposed to widen the distributor base by including postal agents, retired bank officials, government and teaching fraternity, for distribution of simple products.
While this will energise the distribution network, there exists a potential risk of mis-selling of schemes to investors due to lack of knowledge and understanding, on the part of these individuals, of the complexities of current mutual fund products.
Though one awaits the fine print of the amendments, the announcements from SEBI should be implemented in the right spirit. They reflect an effort on the part of the Regulator to address some of the challenges faced by the industry.
Proposed Amendments by SEBI – Steps towards Growth of the Mutual Fund Industry?
(Excerpts from a release by Quantum Asset Management Company Private Ltd )