Home / Money / Personal-finance /  Sebi move to curb mis-selling in mutual funds

It’s good news that capital markets regulator Securities and Exchange Board of India (Sebi) brought down the costs (total expense ratio or TER) that mutual funds can charge you, a decision it announced on 18 September. The guidelines were revised 22 years after Sebi first fixed the limits of the annual costs that MFs can charge for managing your money. But what got buried in that announcement is this: closed-end equity funds will only be able to charge a maximum of 1.25% of TER. 

Sebi’s aim is to not just bring the costs down but also to clamp down on mis-selling. Here’s how your life—as a mutual fund investor—will change. 

Fewer closed-end funds 

Closed-end funds aren’t bad, per se. But in the name of differentiation, MFs have often launched similar products such as closed-end equity funds. Between 2013 and now, 209 closed-end equity funds were launched that collected a little over 46,130 crore. Fund houses like ICICI Prudential Asset Management, Sundaram Asset Management Co. Ltd, Aditya Birla Sun Life Asset Management Co. Ltd and Reliance Nippon Life Asset Management Co. Ltd launched a series of funds with similar themes, but all of them were closed-end and were an opportunity to collect a corpus at regular intervals. There were many other fund houses as well.  

Being small-sized for most of their lives, closed-end funds allowed fund houses to charge a maximum of 2.5% expenses. But did they deliver? According to figures by Value Research, closed-end mid-cap funds returned 12.35% in the past three years, as against 12.21% by open-ended funds in the same tenure. Not much to differentiate. However, in the last 1-year period, closed-end small-cap funds and closed-end mid-cap funds fell more than their open-ended counterparts. “Closed-end funds, at large, have not been really sold on merit. They have been an asset gathering exercise. With reduced expenses, fund houses will now no longer be able to sell closed-end funds in the manner that they did (at frequent intervals). It’s only when a fund house has a really differentiated idea will they now launch closed-end funds," said Kailash Kulkarni, CEO, L&T Investment Management Ltd.

“The regulator has already communicated that approvals for closed-end funds with a similar mandate as what already exists in another fund, will not be given going forward. We have halted launches in this segment (equity oriented)," said a CEO of an asset management company, who did not want to be named.  

Distributor fee structure 

It’s not just about reduction in expenses, but also how distributors are compensated. Sebi has mandated that there should be no upfront commission or upfronting of trail commission when it comes to distributor payouts. The industry must now shift to an all-trail commission model. An upfront commission is paid by the AMC to the distributor at the time when the sale is made and trail commission is paid annually as long as the funds remain with the AMC. 

Previously, at the behest of Sebi, in early 2015, industry lobby Association of Mutual Funds of India (Amfi) announced that AMCs should limit upfront commission to 1%. However, in practice, standard upfront commission for some distributors on specific schemes was being stretched to 1.25-1.5%. No upfront commission is a big step towards removing conflict in closed-end and open-ended schemes. 

According to Rajesh Iyer, chief executive officer, DHFL Pramerica Asset Management Company, “It’s going to have an immediate negative impact predominantly for certain segments of IFAs and some of the consumer banks who have still relied on an upfront fee booking model. But there is recognition that the longer term opportunity is much bigger."

Also, in case of closed-end schemes where it is certain that the assets that comes in will remain for the said 3- or 5-year tenure, the entire trail commission was paid upfront. This meant a payout of around 4.5-6% upfront in many instances. This enlarged payout somewhat tilted the balance in their favour despite there being no performance incentive for investors putting money in these. There are at least 147 closed-end equity schemes being managed today, out of which 128 were launched in 2015 or later. 

This phenomenon is likely to change, forcing a segment of the industry to alter strategy. “In the normal course of business, redemptions will continue,  plus on money on account of closed-end funds, maturities may not come back. Removal of upfront and reduction of commissions will make some segments of distribution disinterested. This may lead to decline in inflows even as redemptions continue and immediate negative net inflow once these changes are effective," said Aashish Somaiyyaa, chief executive officer, Motilal Oswal Asset Management Co. Ltd. 

Large-sized fund houses will show less expenses 

Sebi’s new formula is more updated than its previous one. In 1996, when Sebi fixed the TER formula, it had accounted for scheme corpus sizes of about 1,000 crore. But in the past 10 years, schemes have grown much bigger. The industry has grown manifold since, and adjusting this scale to larger scheme sizes was the need of the hour. The new TER reduces progressively beyond the 10,000 crore scheme asset size (see graph). There are at least 25 schemes within equity diversified funds and hybrid funds, which currently have assets under management above 10,000 crore. Plus, around seven debt funds, excluding low duration, liquid and money market schemes, have a size of above 10,000 crore. 

“This has been in discussions for over a year now and should have been expected. The good part is that the slab-based cut aims to give a level playing field to smaller AMCs. Though the other side of argument could be that the larger AMCs have benefitted from the earlier system (upfronting), helping them build size; while the smaller and newer AMCs will not have this option. In a structural growth market like India, dynamics are evolving and there will be regulatory changes; one has to evolve with it," said Iyer.

Tadit Kundu contributed to this story

Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.
Recommended For You
Edit Profile
Get alerts on WhatsApp
Set Preferences My ReadsFeedbackRedeem a Gift CardLogout