Keep an eye on the fund expenses and load structure to get the maximum out of your fund
Swimming in mutual fund waters often means you'll frequently have to deal with the shark of hidden costs, which could take a big bite out of your returns. The only way to prevent an unexpected attack is to carefully think things through before you invest. That means reading the fine print carefully to ensure that your mutual fund provides returns that match your risks.
In the US , not long ago, 75 per cent of the funds were load funds. But as investors became more sophisticated and spruced up their bargaining power, the proportion of funds is now shifting closer to 50-50. In India, most equity funds investments have accompanying entry and exit loads, while income funds usually tend to be free of such charges.
So what are these hidden costs? And how do they affect your investments? Mutual funds levy various costs and charges at different points of the investment cycle -- entry and exit loads besides annual recurring expenses.
An entry load is charged when you purchase units of a mutual fund. For example, if you invest Rs 10,000 in an equity fund with a net asset value (NAV) of Rs 10 and an entry load of two per cent, you end up with 980.39 units (Rs 10,000/10.2), not 1,000 units. In effect, you're paying more than the NAV when you purchase units that carry an entry load.
Similarly, when you sell your investments, many funds impose an exit load. For instance, suppose you invested Rs 10,000 in an equity fund with an NAV of Rs 10, which charges an exit load of two per cent. If the NAV appreciates to Rs 12, you won't get Rs 12 for each unit you decide to cash out of; instead, your NAV will be calculated as Rs 11.76. The exit load slices off a part of your returns here.
It's clear that these additional costs only serve to lower your overall returns. That's why it makes imminent sense to invest in funds with low load charges to minimise your investment cost.
Loads are not fixed, they change from time to time. Exit loads are used to penalise investors who enter and exit a mutual fund frequently. For instance, some income funds imposes an exit load of 0.5 per cent on redemptions within six months of purchase.
Says Prakash B Dalal, Chief Marketing Officer, Kotak Mahindra Mutual Fund, "Income funds mainly use exit loads to maintain some amount of stability in the fund. For instance, in a long term bond fund, you invest in longer duration papers, so ideally you would not want investors to move in and out of the fund very frequently."
Another item on your checklist should be to look at whether a fund charges loads determined by the size of investment. For instance, some funds charge a contingent exit load for redemptions within a given period (say six months), only for investments below a certain amount. Large investors are not charged any exit load. Clearly, it's a policy that benefits large investors at the expense of small ones. Says an industry official, "The load charges differ because for small investors a flat brokerage charge of 0.50 per cent is charged, so in order to recover the cost, funds charge a higher exit load charge for smaller investors."
Large funds are usually more cost-effective than small ones, primarily because their costs as a percentage of the total corpus drop as the size of the corpus increases. Agrees C Jayaram, chief executive officer,Kotak Mahindra Mutual Fund, "Large funds are more profitable as they enjoy economies of scale.
