Lower Mutual Fund costs

Wednesday, September 19th, 2018

In its board meeting on Monday cleared a number of proposals with regards to mutual funds that bode well for the long term health of the sector.

Firstly, SEBI has created new caps on the total expense ratio (TER) for most funds. However, it allowed an extra 30 basis points for selling in B-30 (beyond top 30) cities. The revised structure is as follows:

According to CLSA, the lowering of TER could lead to a 15-25 basis point reduction in fees. This will level the playing field between AMC’s and force the benefits of economies of scale to accrue to investors. Earlier we had a very odd situation where the largest AMC’s had the highest expense ratios, which is the reverse of what you would expect!

Secondly, Sebi said all mutual fund commissions and expenses must be paid from the scheme itself. This will go a long way to curb “”Marketing expenses” that fund-houses use to incentivise distributors. We could see a lot less “international distributor meets” arranged by asset management companies.

Finally, the regulator has said that the industry must adopt a full trail model of commission in all schemes without paying any upfront commission. This will reduce churn for investors and also result in the exit of distributors who churn portfolio constantly to earn their fees. The trail model aligns incentives correctly and would be very healthy for long term returns.

What are the possible negative impacts of this? AMC’s have already talked about how the cut in expense ratios would be majorly passed on to distributors. This would particularly hurt the smaller IFAs and could lead to some exiting the business. With the advent of an all-trail model, we may see banks and other intermediaries push more costly products such as AIF’s, PMS and ULIPs instead of mutual funds. Such products are far less transparent, command higher fees and have a mixed track record on returns. Unfortunately, this would not stop a lot of distributors, who would be motivated by the commission they would earn. Similarly, for an all-trail model, investments for smaller investors get less lucrative from the distributor point of view and therefore we can see less interest in mutual fund penetration at smaller ticket sizes.

Overall though, lower charges will boost returns for the end investor and the switch to all trail model will ensure that distributors’ incentives are more in line with the clients’ long term wealth creation.

About the author

Rishad is the founder of Kairos Capital. He started his career with Standard Chartered Wealth Management and has extensive experience in markets, particularly in terms of mutual funds and stocks.

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