Sebi’s new steps may ring in a Rs 775 crore windfall for mutual funds

While there has been wide criticism on plans to re-introduce entry load on mutual fund investments, a look at the steps taken by the Securities and Exchange Board of India (Sebi) in its board meeting on Thursday leads to the conclusion that even a “regressive” measure like the introduction of entry load of 1 per cent could have actually been better for investors than the proposal for the additional TER (Total Expense Ratio) of up to 50 basis points (bps) that finally passed muster.

Through the twin measures (additional TER of 30 basis points and 20 bps respectively) that is slated to push the expense ratio up by an aggregate of up to 50 bps, Asset Management Companies (AMCs) stand to make additional revenue of around Rs 775 crore per annum on the total outstanding equity assets under management of Rs 1,55,132 crore as on July 31, 2012. However, if Sebi had chosen to introduce an entry load of 1 per cent on the new sales during the year the burden on investors was likely to have been far lower.

According to the data available with AMFI (Association of Mutual Funds of India), total equity sales during the last 12 months stood at Rs 42,570 crore and a 1 per cent charge on that comes to Rs 425 crore, which is significantly lower than the Rs 775 crore that will go in the form of higher expense ratio from the entire equity AUM.

A hike in expense ratio is more dangerous also because in the case of entry load, 1 per cent would have gone only on the investment amount during the year but in the case of higher expense ratio, it will go on both new and old investment, which will only compound the cost for investors every year. Since mutual fund is a long-term product for 5, 10 or 20 years, an investor will end up paying a far higher amount over the tenure of investment.

Consider this: If you invest Rs 1 lakh every year for 20 years and the investment grows at 10 per cent per annum, at an expense ratio of 2 per cent, your total outgo stands at Rs 8.6 lakh over 20 years but at an expense ratio of 2.5 per cent it will jump to 10.75 lakh. Thus the burden of this additional expense ratio of 50 basis points is not a few thousands but Rs 2.15 lakh over the tenure of investment.

A higher expense ratio guarantees an increase in revenue for mutual funds every year whether they take special efforts or not for penetration but an increase in entry load of 1 per cent for sales beyond 15 cities would have ensured that they take special efforts to earn more. Sebi’s action is also a blow for existing investors as they will be funding the AMCs for penetrating into smaller cities.

While Sebi has asked AMC’s to credit the exit load (charged on early withdrawal) back to the scheme, which is widely seen as a positive move, exiting investors of the scheme will have to hope that more than 20 per cent of the assets are redeemed within one year by certain investors in order to be able to benefit from the same.

For example: If the size of a scheme is Rs 1,000 crore and only 10 per cent of the assets (Rs 100 crore) are redeemed within one year of investment then Rs 1 crore (1 per cent exit load) is collected as exit load and will be added back to the scheme taking the AUM to Rs 901 crore. However, since AMC’s have been allowed to claw back an additional TER of 20 basis points on the entire scheme AUM, Rs 1.8 crore (0.2 per cent of Rs 901 crore) will be charged by AMC’s from the scheme which will bring the AUM down to Rs 899.2 crore. This is lower than Rs 900 crore that would have been as per old regulations and thus long- term investors in the scheme are at a loss.

However if 25 per cent of the assets are redeemed within one year of investment then with exit load coming back to the scheme, the AUM will stand at Rs 752.5 crore and even if 20 bps are taken out of the scheme by AMCs, the AUM will stand at Rs 751 crore, which is higher than Rs 750 crore as per the old regulations. This will benefit the long term investors.

Source: http://www.indianexpress.com/news/sebis-new-steps-may-ring-in-a-rs-775-crore-windfall-for-mutual-funds/990825/0