The uncertainty surrounding what capital markets regulator Securities and Exchange Board of India (Sebi) would be doing with regard to expenses in mutual funds is over. This was a Damocles sword that was hanging in the air for a long time. Now the suspense is over and a slew of changes have been announced after Sebi’s board meeting.

The changes

The TER (total expense ratio) slabs of MFs have been lowered by 0.25% in both equity and debt. The current uppermost slab starts at 2.25% for equity ( 2% for other schemes). Earlier, above 700 crore, equity funds were allowed to charge 1.75% of the scheme’s assets under management (AUM). Now, there are many more slabs where the TER keeps coming down. In the highest slab of above 50,000 crore, the TER for equity funds would be 1.05% of the scheme AUM. The 0.3% charge on the scheme for penetration into beyond the top 30 cities/towns is still intact, but only on retail inflows. Also, the TER in closed-end equity funds is restricted to 1.25% per annum and for other funds to 1% per annum.

In the interest of greater transparency, upfront commissions are not allowed and neither is upfronting of trail commissions. The payouts are to be entirely as trail commissions only. The other change is that now fund houses can pay commissions or incur expenses only from the scheme income.  

Altering the industry

These are significant changes, and may appear as a bitter pill to the industry. But this is probably coming at the right time for the MF industry and seeks to weed out some unhealthy practices, lower charges and bring in more transparency and moderation in the way the fund houses remunerate their agency force. 

All the stakeholders need to do well. The fund house, the distributors, investors and others in the ecosystem such as R&T (registrar and transfer) agents are all stakeholders, but often, the investor is left out of the equation. But it is the investor’s money the MFs are managing, and it is the investor who is ultimately paying commissions. 

The total expenses slabs were fixed in 1996 when the industry was at about 50,000 crore. Now it is over 25 trillion. When the industry has grown over 50 times, why should the investor not partake in the benefits of economies of scale? 

Self-Regulation could have worked

There are over 40 fund houses offering MF schemes in almost all categories and sub-categories. One would expect the competition to drive down the total expenses they charge. But nothing of that sort has happened. Almost all fund houses have been charging the maximum they can. This is like selling at MRP, when there is no restriction on selling at lower prices. 

Regulators step in when the sense of equity and fairness is violated. In this case, the investor is a major stakeholder but does not have a voice or any control over the industry, though it is her money that is being managed. The regulator also steps in when there are practices that are either unsavoury or go against the spirit of the regulation, or to nudge the industry in the intended direction.

 Is regulatory tightening bad

In the near term, there will be a dip in revenues for distributors and in the profitability for fund houses. But they will catch up within a couple of years as the industry surges ahead. In some ways what is happening is good for the industry and the distribution community. 

Firstly, the lower TER would mean better alpha in the schemes. This is sorely required as generating alpha is more difficult now as the Total Return Index has become the benchmark and as the market itself starts maturing. Index funds and exchange-traded funds (ETFs) will also gain traction in the coming years and a TER reduction on actively managed funds augurs well here. 

Secondly, online direct platforms are gaining ground these days. The lowered TER of regular plans would help the distribution community to better compete on price, while offering services not available through platforms. 

Thirdly, lower expenses and hence better returns would be an enabler to bring in even more customers into the industry fold. That would mean more business for everyone.  

The pause before the leap

There are major changes sweeping several industries. In comparison, what is happening in the MF industry is rather modest. Retail, IT, telecom and pharma are but four industries where the magnitude of the changes and disruptions has been of a much higher order. 

The changes suggested would set up the industry for continued, explosive growth. MF assets are expected to touch 100 trillion by 2025. MFs are the right vehicles for investment. Distributors should not get disheartened and move to other products due to these changes as the potential for growth is enormous. 

 That would benefit everyone in the industry. Sharing the fruits of heady growth with investors is the right thing to do. They are the ones who are going to take the industry to those dizzy levels. No one should grudge this small incentive to them.

Suresh Sadagopan is founder, Ladder7 Financial Advisories

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