Investing in mutual funds may soon get cheaper, more lucrative; here's how

Expenses of direct plans set to fall further as distributors' costs will have to be borne by schemes

Over the past decade, the Securities and Exchange Board of India (Sebi) has consistently expressed concerns, and taken several steps to reduce the expense ratio of mutual funds (MFs). Therefore, its latest salvo – cutting expenses further and banning upfront commission – doesn’t come as a surprise.

The latest guidelines will reduce expense ratios further, depending on the size of the scheme. Industry players estimate the impact will be to the tune of 10 basis points (bps) to 30 bps for schemes between Rs 10 billion and Rs 300 billion – a significant reduction for an investor putting money for a longer period of time.

Until now, the highest commission that could be paid by equity MFs was 2.50 per cent. This has now been capped at 2.25 per cent. “Reduction in expense ratios is positive for investors. Their cost of investing will become cheaper, and that will enhance returns,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India. Though expense ratios have been lowered both for equity and debt funds, the impact will be higher in the case of equity funds.

Removing the upfront commission is also a good move, according to experts. “Earlier, if a distributor churned the client every year, he could collect both the upfront and the trail commission every year. Now that the upfront commission has been done away with, there will be no incentive to churn,” says Belapurkar.

Says Radhika Gupta, chief executive officer, Edelweiss Mutual Fund: “Killing of upfront commission and moving to an all-trail model is a very healthy incentive model. It encourages building of long-term assets. The distribution partner will stay with a fund and benefit from the growth in asset under management.” Earlier, some fund houses followed an all-trail model while others followed an upfront plus trail model. Now all will be forced to move to an all-trail model.

According to Dhirendra Kumar, chief executive officer, Value Research, a Delhi-based MF research agency, the transition may not be very smooth as there could be some pain in the medium term for the industry, but this step will improve transparency substantially.
 

What is more significant is that fund houses can now pay expense ratio only from the scheme, and not from the asset management company/associate/sponsor/trustee. This will make direct plans cheaper.

“Currently, the Sebi rule says the expense ratio of direct plans should be regular plans minus the sales/distribution cost. However, with asset management companies paying part of the sales/distribution expenses from their books, there is no transparency to this cost. So, direct plan investors were not getting the entire benefit. Now, with the scheme bearing this cost, there will be clarity on distribution cost, and hence, more benefit for direct investors,” explains Kumar.