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Friday, March 16, 2018

Cost of Investment in Mutual Funds are expected to reduce


Dear Readers,

Earlier scenario for Mutual Fund houses was difficult as far as business beyond, Metros and tier-1 cities. It changed over a period of time. In the recent past, B15 cities have recorded faster growth as compared to that recorded by T15 cities. 

As per the AMFI (Association of Mutual Funds in India) data released for February, contribution of B15 in the Assets under Management (AUM) of the mutual fund industry grew by 41.7% as compared to that during the same time last year. Between February 2017 and February 2018, industry’s total AUM grew at 25.3%.

The rationale behind is falling interest rates in bank deposits and subdued performance of gold and real estate. Mutual fund houses are reaping the benefits of various investor education initiatives. 

Reaching out to investors from the smaller towns was always a challenge. To overcome this, Securities and Exchange Board of India (SEBI) allowed mutual funds to charge 30 basis points (bps) additional expense ratio on new inflows on them satisfying the following criteria:

New inflows from B15 cities shall be at least 30% of gross new inflows in the scheme.
Or
New inflows from B15 shall be 15% of the average assets under management (year to date) of the scheme.

Now as per recent amendment issued, SEBI circular dated 2nd Feb, 2018, the capital market regulator decided to substitute T15 with T30 and B15 with B30 respectively in relevant places.

In other words, the reward of additional 30bps in the Total Expense Ratio (TER) will be given to a mutual fund house only if it garners the pre-specified percentage of total AUM from beyond the top 30 cities.  

The regulator is also going to push the mutual fund industry to further reduce its TER.

Usually bigger schemes enjoy economies of scale; but when the AUM decreases, they start losing out economies of operation and start charging existing investors higher TER.

To deal with this loophole, SEBI had asked mutual funds to plough back the exit load to the scheme, which until then was going into the profit and loss account of the Asset Management Companies. And to compensate for this loss, it allowed mutual funds to charge additional expenses of 20bps.  

Now that mutual fund inflows are extremely stable and the investor base is also expanding, SEBI feels mutual funds can easily absorb the redemption pressure without being compensated by 20bps of additional expenses. This in general happens whenever the market is in bull phase, though vice versa has never been witnessed.

At the board meeting scheduled on March 28, 2018, SEBI will take up this topic for discussion. The capital market regulator is expected to reduce the compensation fee from 20bps.

Let us suppose if its 5bps then, as a result investing in mutual funds is likely to get cheaper by 20%. The impact would be felt prominently on equity schemes. TER of equity diversified schemes (under regular plan) ranges from 3.31% and 1.09%. This range might shift lower to 2.65% to 0.87%; which will be a sure shot positive for the industry overall. 

For direct plans the TER of equity diversified schemes currently range from 2.65% to 0.22%. Now their TER may revolve in the range of 2.12% and 0.18% depending on the AMC and the scheme AUM.

SEBI is trying to make it more transparent, especially the disclosures about TER. The capital market regulator has already made it mandatory for mutual fund houses to declare the TER of all schemes on daily basis under a separate head – “Total Expense Ratio of Mutual Fund Schemes.”

What investors should do?

Although, investing in a scheme that manages its costs well is important, lower TER shouldn’t be the sole criterion to invest or not to invest in a scheme. Impeccable track record is the most important parameter when selecting one mutual fund scheme over others.

Thumb Rule: “Always focus on your financial goals, risk profile & opt for availing the services of a professional before investing in mutual funds.” – Varun Vaid

Regards,

 Varun Vaid & Master Mind Financial Advisory Team

+91 – 9814612907; +91 – 0172 – 4623907

Twitter: @vaid_varun

Email: director@mmfa.in; operations@mmfa.in

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