Market regulator’s fee curb move offers scope for reduction in expense ratio of mutual funds

In a bid to curb the practice of unfairly charging high fees from mutual fund investors, SEBI, based on data and the recommendations of the Mutual Fund Advisory Committee, approved the proposal to reduce the maximum additional expense permitted to be charged to a mutual fund in lieu of exit load credited to the scheme — to five basis points from 20 basis points.

Until 2012, mutual funds in effect pocketed the exit load — imposed on certain schemes on exit within a specified time period — charged by them. But in September 2012, mutual funds were asked to credit the amount collected as exit load back into the scheme. Instead, funds were allowed to charge an additional 20 basis points in their expense ratio in lieu of the amount credited.

Concerned over the higher fees charged by funds on this pretext, SEBI has moved to accept the recommendation of the committee and reduced the permissible charge to five basis points in expense ratio in lieu of the exit load permitted.

Of the total 913 open-ended mutual funds, more than half — 558, charge exit loads on their schemes. While the SEBI move may lead to reduction in expense ratios at some of these funds, the relief to investors may not be broad-based.

This is because funds can charge other additional expenses over the prescribed cap on expense ratio, which can limit the gain on account of SEBI’s move on exit load.

What’s expense ratio?

Mutual funds charge investors for managing their schemes. This charge is called the total expense ratio (TER). Recurring expenses, such as the management fee, distributor commission, registrar fee, trustee fee and marketing expenses — total up to the TER, which is expressed as a percentage of assets managed.

In India, the maximum TER that a fund can charge its investors is prescribed by SEBI. Equity-oriented funds are allowed to charge a TER of 2.5 per cent. The cap is set lower for debt and index funds at 2.25 per cent and 1.5 per cent, respectively.

Over the prescribed cap

SEBI guidelines further set sub-limits for TER based on the size of the assets managed. For equity schemes, fund houses can charge 2.5 per cent for the first ₹100 crore, 2.25 per cent for ₹100-400 crore, 2 per cent on the next ₹400-700 crore and 1.75 per cent on any sums above ₹700 crore.

For debt schemes, the limit is 25 basis points lower in each slabs.

While SEBI has prescribed the maximum cap on expenses, many funds sport an expense ratio over and above the prescribed limit. How?

This is because funds get to charge an additional 30 basis points if the inflows come from beyond the top 30 cities; another 20 basis on other permissible expenses. Fund houses can also charge for the service tax on the management fee. Hence, an equity fund with a corpus up to ₹100 crore may end up charging an expense ratio of up to 3.3 per cent.

Hence, it is unclear now how the reduction in the permissible charge in lieu of exit load credit will impact expense ratios of funds.

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