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MFAC recommends hike in expense ratio by 25 bps

The proposal to raise the expense ratio, if approved by SEBI, could result in unitholders spending almost 25 bps more than what they are paying now

July 19, 2012 2:06 IST | India Infoline News Service
The 14-member mutual fund advisory committee (MFAC) appointed by the Securities and Exchange Board of India (SEBI) has recommended raising the total expense ratio and exclude service tax from this fee.

Expense ratio refers to the amount charged by mutual funds to manage and operate schemes. The Committee has also suggested to SEBI to allow greater flexibility for mutual funds to use the expense ratio, which includes management fees, administrative fees and other operating costs.

The proposal to raise the expense ratio, if approved by SEBI, could result in unitholders spending almost 25 basis points (0.25%) more than what they are paying now. The MFAC recommended raising the expense ratio to 2.5% from 2.25%. The exclusion of the service tax of 10.3% from the expense ratio will result in investors incurring costs of another 30 basis points.

Mutual funds will be able to manage expenses better if SEBI allows them flexibility to use the expense ratio. At present, mutual funds are allowed to charge up to 2.25% (in funds with assets in excess of Rs. 100 crore) as expense ratio. Out of the 2.25% charged as expense ratio, fund houses are allowed to accept only 1% as asset management charges; the remaining 1.25% has to be mandatorily used to meet recurring expenses, which include payment of annual trail fees, auditor & registrar charges and dealing charges to empanelled brokers. 

 “The expense ratio was envisaged for recovery of, amongst others, costs incurred by AMCs (asset management companies) in management of funds. The levy of service-tax on fees collected by AMCs was introduced subsequently, effectively limiting the amount available for the AMCs. Removal of service-tax from the expense ratio is, therefore, a logical step,” Gautam Mehra, leader-asset management, PwC India, said.
 
He further said, “Both the proposed changes of increase in the expense ratio by 25 bps and removal of the levy of service-tax from the expense ratio would incentivise investments in the mutual fund industry, which has been facing strong headwinds. As managing mutual funds becomes more sustainable, it should help the investor community in the long run.”

According to Pankaaj Maalde, head-financial planning, ApnaPaisa.com, “The increase in total expense ratio will hit investors badly and will reduce their overall return. One should note that it will be applicable on total existing mutual funds AUM (assets under management) of Rs. 7 trillion and 0.25% more works out to around Rs. 1,750 crore yearly. Investors should also note that SEBI's move will help in reviving the mutual fund industry and the performance is not guaranteed by this huge increase.”

Vivek Chaurasia, senior research analyst, PersonalFN, said, “Mutual fund industry has been crying for funds to compensate their distributors or money gatherers who can sell their products despite decent performance or not and thus help these AMCs raise fresh AUM. The increase in expense ratio may surely increase the cost for investors in the schemes having corpus of over Rs. 100 crore, if the funds with large corpus go for an increase in their expense ratio. The exclusion of the service tax from the expense ratio is an additional burden for the investors. This step may only help improve the balance sheet of the AMC and distributors, at the cost of investors. However it is better than the return of entry load, which would have hampered the confidence of investors.”

Mr Maalde further added, “Entry load of 2% was banned to protect the interest of investors and reduce their overall outgo. The impact of hike in fees will be much higher than 2% entry load as the entry load was levied only on new investments whereas the hike in fees will be applicable to the total investment made in the mutual fund industry. The expense ratio on debt fund is already high and should be reduced as over all return on debt funds hardly touches double digit. Regulators are making decisions more in the interest of AMCs and investors’ interest is ignored. The finance ministry must look into this as it is going to work against the investors.” 

Mr Chaurasia added, “Going ahead fund managers should make sure to deliver in terms of performance to compensate for the hike in expense ratio. If the fund managers fail to deliver then the investor will be losing at least around 3% every year with negligible returns in equity. Thus, instead of attracting fresh money, they will be losing investors as well. The actual growth of the Indian mutual fund industry will happen with the performance that can attract long-term money and not by how much the asset managers’ pay to the distributors.”

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