Small investors who put money into mutual fund schemes launched in 2005 may be indirectly paying for the costs incurred by the asset management company in attracting large investors who might have already exited these funds, many of which have underperformed.
The large investors were lured to the fund by paying brokers and distributors (such as banks) a sizeable commission, usually around 4%, and rather than write it off as a one-time expense, most asset management companies chose to amortize it or spread it out over a period of time, usually five years.
Stock market regulator, Securities and Exchange Board of India (Sebi), changed its rules regarding issue expenses in April 2006 to prevent this, but in 2005 alone, by some estimates, 41 new fund schemes spent Rs1,300 crore in commissions, to raise Rs27,400 crore from investors.
The aggregate assets of these firms is now lower by around Rs7,000 crore, or 25%. Some funds that raised amounts as high as Rs500 crore have seen their corpus shrink by 90%. And most of these schemes have returned lower than the Bombay Stock Exchange’s 30-stock Sensex or the S&P CNX Nifty, the National Stock Exchange’s index of 50 stocks.
For instance, JM Emerging Leaders fell 26% in the year ended 5 April 2007; the Sensex gained 9.44% in the same period. Similarly, ABN Amro Dividend Yield Fund lost 21%, the highest among dividend yield funds. It collected Rs436 crore during its launch in August 2005 but its asset base has now shrunk by 95% to Rs21 crore (at the end of February 2007).
The schemes were launched at a time when Sebi allowed such companies to spend up to 6% of their collections as launch expenses. It further allowed the companies to spread it over five years rather than writing it off as an initial or one-time expense. This meant the net asset value (NAV) of the scheme, which ought to be Rs9.40 per Rs10 unit, after deducting expenses and assuming no appreciation, would instead be Rs 9.80 a unit or more.
The problem arises when investors exit these funds. Thus, a fund that raised Rs100 crore, incurred Rs4 crore as initial expenses and decided to write this off over four years, would still have Rs2 crore left to write off at the end of its second year of operation. If its corpus drops to Rs10 crore by the end of the second year (a 90% drop), those who stay invested have to foot the bill. The treatment of deferred expenses hurts those who stay invested.
Asset management companies claim that they have taken adequate measures to ensure that such investors do not suffer. Nikhil Johri, managing director, ABN Amro Asset Management (India)Ltd said 95% of the expenses in ABN Amro Dividend Yield Fund have already been written off. It had changed its norms in April 2006, when Sebi came up with new rules. “Even for the schemes launched prior to this period, we had started recovering the initial issue expenses from the outgoing investors,” he said. Raghvendra Nath, vice-president for marketing & strategy, Birla Sun Life AMC Ltd, maintained that the fund house had lowered the investment management fees that it charges, in order to ensure that investors who stay invested in its schemes do not suffer.
And a senior executive at JM Mutual Fund, who didn’t wish to be identified, said the fund house has accelerated the time period over which it was writing-off the initial issue expenses in the JM Emerging Leaders Fund, which has seen its corpus reduce by 71% since its launch in April 2005.
Till April 2006, fund houses used to spend big money on advertising and would pay a high commission to distributors. Sebi’s new guidelines stopped this trend by mandating that open-ended schemes could recover initial issue expenses only to the extent of the entry load they levied.
Closed-ended schemes are still allowed to charge initial issue expenses up to 6% of the initial collections, which have to be recovered from the investors over the life of the scheme. Since the new rules came in, there has been a rush to launch closed-ended schemes: 20 such schemes compared with 12 open-ended ones have been launched. “While amortization has been scrapped, it has made a back-door entry through the launch of closed-ended schemes which eventually become open-ended at the end of the three-year tenure,” says Sameer Kamdar, country head for mutual funds at Mata Securities, a mutual fund distributor.