Rise in brokerage to eat into mutual fund returns

The move by asset management companies (AMCs) to deduct a portion of the service tax from the brokerage paid to distributors could lead to higher brokerage rates.

This could mean a rise in the expense ratio of various mutual fund schemes. In other words, the returns to investors could be proportionately lower.

The Union Budget has made mutual funds liable for payment of service tax. The funds, in turn, have decided that a portion of the levy can be passed on 'passively' to the distributors by deducting it from the brokerage paid to them.

The move is not expected to severely impact distributor commission since the asset management companies will be paying them higher brokerages.

A Mumbai-based distributor with a good retail base said, "Mutual funds have been kind enough to increase the brokerage so that the net impact of the deduction will be nil."

The distributors are happy that the onus of paying the service tax does not fall on them since it involves tedious paperwork, even as they also get to retain their commission.

Expense ratio is a mutual fund's total expenses expressed as a percentage of its average corpus through the year and they measure the charges made against the income earned by the schemes.

Which means that higher the expense ratio, lower the returns to the investors.

The costs charged to mutual fund schemes are mainly distribution costs, asset management fees, marketing and operational expenses.

Out of this distribution costs consisting of brokerage paid out to distributors form the largest chunk.

Brokerages have shot up to over four per cent against the normal 2.5 per cent. This might go up even further. Expense ratios are capped at 2.5 per cent (of the corpus) for equity schemes and 2.25 per cent for debt schemes.

Expense ratios typically go up when the corpus goes down, and funds have seen their expense ratios mount recently with some of the fund houses facing severe redemptions.

Industry sources said that mutual funds under the Association of Mutual Funds of India is likely to make a representation to Sebi to increase the expense ratios.

However, this will not provide any relief to the investors, who will only see their returns diminishing.