July 31, 2012

steering mutual fund investors to pay more to fund managers

I contributed an editorial two weeks back on the issue of potential rise in costs for mutual fund investors as recommended by a regulator-nominated committee. Here is what I wrote in that contribution:

Investor un-friendly
Sebi advisory committee on mutual funds has made some progressive and some regressive proposals

The last one month has seen mutual fund investors being psychologically prepared to bear additional annual fund charges while investing in mutual fund schemes. It gives a feeling of chickens being prepared for the slaughterhouse. Following Monday's meeting of 14 members of an ongoing Securities and Exchange Board of India-appointed advisory committee on mutual funds along with Sebi officials and finance ministry officials, information leaks from attendees (despite being sworn to secrecy) were designed once again to get mutual fund investors to prepare for an annual expense hike of 0.25 percentage point. 

Since Sebi has to take the final call as the securities market regulator, it will make it convenient for Sebi, reeling under pressure from finance ministry to provide some incentives to the mutual fund industry, to justify a hike. 

This will translate into a rise in investors' cost ranging from 10 per cent to 14 per cent depending on the size of the scheme he is invested in as Sebi-imposed limits on total annual fees ranges from 2.25 per cent on the first Rs 100 crore of their assets under management of a scheme to 1.75 per cent on AUM portion above Rs 700 crore. 

The mutual fund industry is seeking to extract its pound of flesh after Sebi, under the previous chairman, C B Bhave, had banned entry load exactly three years back. The 0.25 percentage point hike is like a backdoor replacement to entry load. The problem is that it makes matters only worse for a portion of the investor population, particularly debt scheme investors and self-driven and progressive investors who prefer to bypass the agent route and invest directly in equity schemes through the asset management companies' websites or branches. 

The proposed new hike will apply to all schemes -- equity, debt and others. Entry load, when it was allowed, was primarily imposed on equity schemes by mutual funds. Thus, investors in debt schemes who never suffered from entry load burden will now have to suffer from the hike in total expense ratio. Further, a few months before Bhave completely banned entry load he had restricted the imposition of entry loads only for those investors subscribing through agents. 

Investors investing directly through AMC websites or branches were thus spared of entry load burden, but now, if annual expense ratio is hiked, they get to bear the brunt too. The fungibility suggestion, where sub-limits on investment fees is being sought to be removed, however, poses no apparent problem to investors as it only provides flexibility on arriving at the level of each charge-head. 

It is strange but in an advisory committee, half of whose members were outside of the industry, did not think it fit to propose charging above the existing limits for schemes which outperform benchmark indices. This would have incentivised fund managers to be more diligent in stock picking. But the committee did make a good proposal of schemes ploughing back collection from exit loads, which is imposed on investors exiting a scheme within a specified period from purchase date, to the scheme instead of giving it to the AMC. 

The committee's proposal of giving AMFI a regulatory role for governing mutual fund distributor, has serious implications. It has the potential to invoke demands from other sections of the securities market, such as stock exchanges seeking regulatory role for governing their brokers. Whether Sebi should outsource regulation responsibilities to an industry body which has a vested interest in keeping their agents happy is something that should be avoided. Sebi needs to tread carefully on all the proposals coming from the committee.

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