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Mutual funds: SEBI, the market regulator in India, is considering a proposal to allow mutual funds (MFs) to charge a fee based on their performance. Currently, the total expense ratio (TER) is charged by investors on a daily basis, irrespective of whether a scheme is performing well or not.

Mutual Fund performance fee plan: How will this benefit investors?

Pankaj Mathpal, MD & CEO at Optima Money Managers said this proposal is justified and it will be in the interest of investors if the TER is linked to the performance of the scheme.

“Right now an equity scheme can charge up to 2.25% of the AUM even if the scheme is underperforming. I think SEBI will allow minimum expenses towards custodian fees, registrar fees, and audit fees, etc. and the performance-linked incentive will be over and above that minimum threshold," added Mathpal.

Over the past few years, SEBI has taken a proactive role in bringing about improvements to investing legislation, assisting retail investors on their path. As per Vinit Khandare, CEO and Founder, MyFundBazaar, this new suggestion seems appropriate given the current situation, where a few mutual fund schemes have consistently underperformed while others have produced exceptional returns on par with the best PMS schemes.

While some contend that these fees can lead to better results for both investors and fund managers, others are skeptical of their efficacy and potential downsides. “On the one hand, since managers are motivated to maximise returns rather than just collecting a predetermined management fee, performance-based fees can match the interests of fund managers with those of investors. This might lead to the fund management exerting more effort and skill, which would benefit investors," said Vinit Khandare.

Scripbox Bharat Phatak is of the opinion that introducing a performance-based incentive is a welcome step.

Challenges in quantifying the value added by fund managers

Typically, the fee structure is a combination of AUM-based fixed fees and a variable fee based on outperformance or ‘alpha’ generated by the fund. The benchmark in the case of active management strategies is an appropriate market index. The logic is that the investor would have been able to get the index performance through passive investment in the index itself. If there is an outperformance over that index, the reward for the fund manager is in the form of a variable incentive, explained Bharat Phatak.

“Investors will have to understand the concept of “relative performance". If the underlying index has given a return of 15%, and the fund NAV has risen by 19%, there is an outperformance of 4%. The fund manager will get an incentive as a percentage of this 4% alpha. This becomes difficult in a period, where the benchmark itself has given a negative outcome. For example, if the index has fallen by 14%, and the NAV of the fund is down only 9%, there is still an ‘alpha’ of 5%. The variable fees are due in this case, but the investors will find it difficult to digest," said Bharat Phatak.

Close-ended funds are in a better position to handle this, if the incentive is paid at the time of maturity of the scheme, and not in between, he added.

Inflow in equity mutual funds drop 68% in April

Inflow in equity mutual funds plunged by 68 per cent to 6,480 crore in April as compared to a record inflow of 20,534 crore registered in the preceding month, data released by the Association of Mutual Funds in India (Amfi) showed on Thursday. Moreover, fund collection through SIPs dropped to 13,727 crore last month from a record 14,276 crore in March. Within equities, the small-cap category and the midcap category once again led the charge receiving flows of 2,182 crore and 1,791 crore, respectively.

 

ABOUT THE AUTHOR
Sangeeta Ojha
A business media enthusiast. Writes on personal finance, banking and real estate.
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Updated: 12 May 2023, 02:24 PM IST
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