New Mutual Fund regulations – MFs become expensive !

Under pressure from the impact of falling investments in mutual funds from investors at the back of the 2009 regulation of removing entry loads, the capital market regulator SEBI (Securities and Exchange Board of India) announced some new measures last week.

For those who are coming into the game a bit late, the removal of entry loads took away distributor commissions and as a result distributors stopped selling mutual funds to investors. To compensate distributors, Asset Management Companies (AMCs) started paying distributors from their own kitty. Commissions paid to the distributors are usually a mix of upfront and trail commissions.

In September 2011, SEBI came out with another regulation which allowed mutual fund distributors to charge investors fees – Rs 100 for investments of Rs 10,000 and above and an extra topping of Rs 50 from first-time investors. Investors who were buying directly from mutual fund houses would not be charged any fee.

Inspite of all this, the decline in mutual fund investments is evident from the fall in AUM (assets under management) of 30% from November 2009 to June 2012. Indian investors are probably putting in money into fixed income instruments like fixed deposits – mutual funds occupy just 5% of an investor’s portfolio.

The latest regulations from SEBI is a desperate gamble to get investor’s flagging interest back in mutual funds.

Mutual funds become more expensive for investors

It is said that 20% of a mutual fund’s investments is pulled out within a year. When investors exit mutual funds, they pay an exit load.

As it stands today, the exit load was used by fund houses to pay distributors. This lead some distributors to encourage churning among investors as any churning only helped them fill their pockets.

SEBI has now ruled that exit load money now needs to be credited back into the mutual fund scheme.

Also, to compensate the fund houses for the exit, SEBI has allowed mutual funds to charge an extra 20 bps over the expense ratio.

Crediting the exit load back to the scheme and not paying distributors means that churning or mis-selling will now be less and investors will stand to gain more.

An increase in expense ratio means that your mutual fund investing is going to become more expensive going forward. Not just this, but the service tax of 12.60% that was till today borne by the fund houses will need to be borne by the investors.

Expense ratio is the amount of money that an AMC charges investors for operating and administrative expense.

Given these two important regulations, the total expense ratio for the investor will now go to around 2.98% – 3.00 % as opposed to the earlier figure of a maximum of 2.50%. Your mutual fund investments just got more expensive !

Taking mutual funds to the masses

SEBI wants more retail investors to put their money into mutual funds. Currently, the top 15 cities in India account for 86% of mutual fund investments.

To boost retail participation from smaller cities, SEBI has said the fund houses can charge an extra 0.30% of additional expense in non metro cities. To charge this extra expense, fund houses will need to get inflows from locations beyond the top 15 cities which should be at least 30% of the total inflows.

But if any of this new inflow coming from beyond the top 15 cities moves out within a year, then the additional expense collected will need to be credited back to the scheme.

The impact this will have is that the total expense ratio for investors will increase. Currently, the expense ratio is 2.50%.

I guess this is a positive move as with a small extra charge, fund houses now have the motivation to reach out to far flung areas (beyond top 15 cities) for investments. This will help retail investors to participate in India’s booming growth and the stock markets, or whatever is left of it.

Others

If you want to take the direct investment route with the fund houses, SEBI has something in store for you.

A new plan with a lower expense ratio is on the anvil for investors who want to invest directly with the fund houses. This will be in addition to the existing retail plans that schemes already have.

Given the fact that for investors, your mutual fund investments are now going to get more expensive, this regulation is like a welcome move. I don’t have much details on this yet but as soon as I have something, I will come back and update the post.

What are your thoughts dear readers ?