Get Set For An Overhaul Of Charges Levied By Mutual Funds

The Securities and Exchange Board of India is working towards formulating what it says is a better way of regulating charges levied by asset management companies in individual mutual fund schemes.

The regulator would come up with a formulation for the new expense structure in consultation with the mutual fund industry, SEBI Chairperson Madhabi Puri Buch said at a press conference that followed the conclusion of the market regulator’s latest board meeting. She said the regulator had no desire to create an adverse impact on the industry, but the guiding principles that govern expense ratios must be followed.

Currently, mutual funds charge unitholders for managing their money in the form of a total expense ratio. This ratio, a percentage of the net asset value of a scheme, includes various costs borne by the asset management company. That includes the cost of hiring fund managers and also distribution costs.

The market regulator has limits for each fund category and every scheme must only levy a total expense ratio within these stipulated limits.

SEBI has conducted a review of the expense ratio and followed certain guiding principles, which Buch enumerated. The first, and most important, she said, was that the total expense ratio should be clear and must cover all expenses.

Economies of scale come into play in fund management, Buch said. These are not applicable at a scheme level, but rather at an asset-class level.

“The unintended consequence of scheme-level (TER regulation) was two-fold—SEBI itself through its regulations was giving an incentive for fragmentation of schemes, which was not good," she said. "That was a very perverse incentive – we have to remove it. It was creating a lot of mis-selling on account of NFOs."

It has been alleged that mutual funds aggressively launch new schemes that are not necessarily different in construction from existing ones in order to garner a higher expense ratio.

The third guiding principle, Buch said, was a contentious issue, but she insisted that a spade must be called a spade. There is no reason for brokerage cost to be outside of the total expense ratio, she said.

Such a practice is tantamount to double charging the unitholder because there is already an inclusion of the cost of hiring a fund manager in the total expense ratio.

“…if you are taking asset management fee to manage the asset, then why are you paying such large sums of money to the broker for the research, which you are supposed to be doing,” Buch said. “We don’t mind—you want to use the research of the brokers, we have no problem. I have been a sell-side investment banker myself, so the last thing I want to do is to kill that profession. But you can’t pretend otherwise. To us it was a double charge—we do not appreciate that.”

The SEBI chairperson said that investigation suggests that there was also a distinct possibility brokerage was being paid other than for professional reasons.

The market regulator undertook a study of the fees and charges levied by mutual funds in December last year. A detailed framework could be released imminently.