HSBC MF scraps exit loads, but keeps TER of 20 bps5 min read . Updated: 26 Feb 2013, 10:01 PM IST
Scrapping of exit loads may encourage churning, which can hurt genuine, long-term investors.
In a surprise move, HSBC Asset Management (India) Ltd has abolished exit loads in all its schemes, effective 1 April 2013. So if you invest in any of HSBC AMC’s mutual fund (MF) schemes after 1 April, you will not need to pay any exit loads when you withdraw investments anytime. Typically, equity funds have an exit load for withdrawals made within a year.
“We felt that exit loads were an entry barrier for many investors and they were just 1% (of the amount withdrawn) which was not significant. Short-term capital gains tax, at 15%, is a much more significant cost than exit loads. Besides, we want to simplify the product," says Puneet Chaddha, CEO, HSBC India AMC.
Exit loads are charges, typically 1-1.5%, that are levied on schemes to dissuade premature redemptions. While an equity fund has exit loads of, typically, 1% for all withdrawals made within a year, bond funds have exit loads that discourage withdrawals made within three months or so.
Other fund houses claim that the 8.26 trillion Indian MF industry should in fact increase exit loads. “It’s not wrong to think that for a long-term investment product, such as an equity fund exit loads should be tightened; even imposed for withdrawals up to two to three years. Else, high networth individuals will churn their investments," says Sandeep Dasgupta, CEO, BOI AXA Investment Managers Ltd.
But that’s not the only way existing investors—or those who prefer to stick with the fund house—could lose out. Effective 1 October 2012, the capital markets regulator, Securities and Exchange Board of India (Sebi), mandated that fund houses must plough money collected through exit load collections back into the MF schemes. This step was meant to discourage fund houses to pay upfront commission to distributors; a part of distribution commission (upfront commission) used to come out from money collected through exit loads. As exit loads were made to plough back to the scheme, AMCs were allowed to charge an additional 20 basis points (bps) to the scheme’s total expense ratio (TER). One bps is a hundredth of a percentage point.
Should a fund house, then, continue to charge exit load expenses on a scheme (in other words, your investments) when it does not collect exit loads on premature withdrawals? “No, it should not ideally," says the head-sales of a fund house, who did not want to be named.
The problem here is a little convoluted. Last year, in a press release issued in August 2012, Sebi said that “in order to encourage long-term holding and to reduce churn and align the interests of the AMCs/distributors with that of the investors, it was decided that… the entire exit loads would be credited to the scheme while the AMCs will be able to charge an additional TER to extent of 20 bps." In simple words, it linked the two—imposing exit loads and 20 bps exit load charges—and made it clear that since fund houses won’t get to enjoy the exit load collections like before, they will be allowed to charge an additional 20 bps exit load charges to the TER of a scheme.
When Sebi issued the guidelines in September, it remained silent on the comparison. “It didn’t crystalize the connection between the two when the final regulations came out. So I think the rules allow all fund houses to charge 20 bps TER. Therefore, a fund house is now legally correct in charging the additional TER of 20 bps despite scrapping exit loads," says Dasgupta.
Says Chaddha: “The way we price our products also depends on the type of the product and the sort of returns it generates. For instance, our bond funds that have a scope for 8-10% returns have a different cost structure than, say, equity funds that can deliver much higher." Chaddha added that some schemes in HSBC MF charge this additional (20 bps) TER, while others don’t.
Not everyone is convinced though. “The 20 bps exit load charge is paid by existing investors. They must be compensated by exit loads—paid by those who withdraw prematurely—that get ploughed back into the scheme. Besides, HSBC MF has scrapped exit loads only for those who invest on or after 1 April. Recent investors will have to pay exit loads if they withdraw prematurely and the 20 bps exit load charges," says Nagpal. He feels that the solution is that Sebi clarifies that MFs can charge additional TER of 20 bps up to a maximum of the exit load charges credited back to the scheme. “That will stop such situations and will truly be compensatory," he says.
Apart from making HSBC MF’s schemes more popular, scrapping of exit loads will serve another purpose, claim some industry officials. Of late, Hongkong and Shanghai Banking Corp. Ltd (HSBC) has been shifting its business model towards the “advisory" model as against the “distributor" model, as per a Mint report published last year (http://tinyurl.com/b3a3c8c)
Sebi’s recent investment advisor guidelines have also nudged distributors to be either “advisors" or “distributors". As per the same report, the bank, a distribution source told us, has moved to a “net sales" incentive system as compared with a “gross sales" incentive system. Net sales is gross sales less redemption. Focusing more on net sales keeps churning in check as higher the net sales (this will result in low redemptions), higher will be the investment advisor’s commission.
A CEO of a large Indian fund house told us, on conditions of anonymity, that HSBC AMC may be comfortable in discouraging upfront commissions as much of its inflows (markets reports suggest about 60%) come from HSBC. “HSBC AMC’s scrapping of exit loads could be in keeping with the overall strategy of the HSBC group. If HSBC discourages upfront commission, HSBC AMC would not need to pay upfront commissions to its largest MF distributor," he says.
Mint Money take
We like exit loads and feel they discourage early withdrawals. Scrapping of exit loads may just encourage churning, a practice that can hurt genuine, long-term investors as well as fund managers. Besides, if a fund house abolishes exit loads but retains the extra 20 bps TER, it hurts existing investors even more. So before investing, focus just on a fund house’s pedigree and performance.