Indian funds are the cheapest and cleanest in the world

A fund will have three kinds of costs—entry, ongoing and exit. By banning entry loads, India has collapsed all costs into the annual cost and the exit load

Now that the dust has settled over last week’s announcements by the Securities and Exchange Board of India (Sebi) and the merits or otherwise of the hike in mutual fund costs have been chewed over, two issues have emerged that still need a comment. One, that Indian funds are the most expensive in the world. Two, that the changes are pro-big fund houses.

The 50 basis point (bps) hike (30 bps for non-metro penetration and 20 bps to take care of the exit load clawback getting ploughed back into the scheme) in expense ratios will bring the entry level cost of an equity fund to 3% a year. Funds are allowed to charge expense ratios on a sliding scale. The first Rs.100 crore of assets under management will now be charged 3% (2.5% earlier), the next Rs.300 crore 2.75%, the next Rs.300 crore 2.5% and all assets after Rs.700 crore will be charged 2.25%. If the average cost was 2% earlier, it will now be 2.5%. Let’s look at what the rest of the world charges: the median annual recurring cost in the US is 0.94%, in UK 1.67%, China 1.3% and South Africa 1.47%. Remember, we’re talking about managed funds and not passive index huggers. At 2.5% annual cost, India is indeed the most expensive. But that is only half the truth; to see the total impact of cost, we need to build in all other costs as well. A fund will have three kinds of costs—entry, ongoing and exit. By banning entry loads, India has collapsed all costs into the annual cost and the exit load. If we build in the 1% exit load on money that leaves an equity fund before 365 days, we get a total cost of 3.5%. Now look at what the US and UK charge. The US, with its three share classes, has costs that range from 1.18% to 7.1%. The UK funds cost an average of 6.67% a year.

Not only are Indian funds the cheapest, they are also the most transparent. Costs in other markets such as the UK and US are not so easy to define. The US, with its various share classes and cost sub-categories, is almost impossible to navigate for an average investor. The UK too seems not to define costs as well. Says financial planner Nick Cann, chief executive of the UK-based Institute of Financial Planning: “The annual management charge on mutual funds in UK varies quite a lot. There’s no set minimum and maximum, 1.5% per annum is pretty typical although 0.5% of that is usually paid away to the adviser (if there is one). Some charge more (specialist funds usually go upto about 2%), others charge less although few go below 1% per annum.” Maybe it’s time we stop beating ourselves up and look at mutual funds as the lowest cost, transparent vehicle for a variety of retail investment needs.

The second crib is around the smaller asset management companies (AMCs) getting short-changed by linking the hike in expense ratios to gathering non-metro business and for the exit load clawback rise in expense ratios. The argument is that this will benefit the larger fund houses. Two points here. One, smaller AMCs are represented on the mutual fund committee and need to use that forum to put their voices across. Two, when a business is started there are no guarantees getting handed out. What prevents a new AMC from coming in with a business plan that looks at focusing on a non-metro region rather than trying to replicate the high-cost 15-metro-heavy existing business model of the large AMCs? The mutual fund industry is more than 20 years old and those that have been there for those many years will have an advantage over the newcomers. I don’t understand why the regulator should give sops to the newbies to make their business profitable.

End note: Out of all the debate, there may emerge some things that may need a tweak. One example is the exit load calculation. The way the numbers are done right now, it seems that the fund houses’ benefit will be a multiplier to that of the investors. Exit load calculations need to be seen on incremental assets gathered by the fund and not on to the total corpus. An update a year later will also help in mapping out how this change has impacted the industry and the investor. Since we know what we are trying to map, possibly the data collection could happen on an ongoing basis rather than defining the data metrics a year later.

Source: http://www.livemint.com/2012/08/21213341/Indian-funds-are-the-cheapest.html