This week SEBI chairman, Upendra Kumar Sinha announced new measures that may lead to increased participation in mutual funds. Let’s analyze the new formula and see who wins and who loses.
Winners:
- 1. Government
- 2. Large fund houses
- 3. Mutual fund Investors in smaller cities
- 4. Investors at large
- 5. Long term Mutual fund investors
Losers:
- 1. Mutual fund investors in large metros
- 2. Existing Mutual fund investors
- 3. Smaller fund houses
Government – The case of the government is very simple. More investment in mutual funds translate to more service tax. In addition, if more money is invested in mutual funds, it may result in less investment (read import) of gold. Gold and oil are India’s largest import items. Reduction in import of gold will help reduce the pressure on Rupee.
Large Mutual Funds – Large mutual funds are the ones that can penetrate smaller cities. According to the new formula, if a MF house has Rs.100 Cr in asset under management (AUM), AND if at least 30 Cr of this has come from places beyond the top-15 cities, the mutual fund house can charge an additional expense of 0.3% on the ENTIRE AUM. In other words, the fund house can charge an additional Rs. 3 La. This is in addition to the other expenses the mutual funds charge.
Another change in the formula was to make the expenses “fungible”. Until now, the fund houses could charge a maximum of 1% as Asset Management Charges, and a maximum of 1.25% to meet recurring cost of running the mutual fund, brokerage charges etc. Fungible means the fund house doesn’t have to break down the costs anymore. It all comes out of the same kitty. In other words, the fund houses now do not have to show the two costs separately. In theory, the loss of transparency in cost, will just enable the fund houses to charge maximum possible, thereby reducing the returns of the investor.
Mutual Fund Investors in small cities – Investors in smaller cities may now see more options as fund houses rush to expand to smaller cities.
Long Term Investors – Sebi has proposed to “plough back” the back end load back into the fund. That means, when an investor divests out of a fund within one year of investment, the charges applied will be added to the fund, thereby increasing the NAV of the existing investors.
Investors at-large – If fund houses succeed in reaching out to smaller cities, and increase their AUM, it will increase the influence of the Indian institutional investors, thereby reducing the downward risks in the market when Foreign Institutional Investors reduce their exposure. This will help stabilize the bourses against drastic changes when “hot money” enters or leaves the investments.
The biggest loser in the new proposal is existing mutual fund investor, especially the ones from the top-15 cities. This planned expansion is at the cost of current investors. Their annual expense will increase from 2.25% to 2.55%.
Another loser in this proposal is small fund houses. If the fund house is not large enough to expand to smaller cities, they will lose the edge to the larger ones.
The intention of SEBI to expand the reach of the fund houses is laudable, but it shouldn’t have come at the cost of the existing investors. The cost of expansion should have been borne either by the fund houses, may be with an assistance from the regulators in the form of incentives.
Given the dismal performance of most fund houses over the last few years, it is the author’s opinion that instead of benefiting the fund houses and the government, the new formula will actually be detrimental to everyone.
According to Smart Investor dated June 12 2012, (http://smartinvestor.in/mf/mfNewsFeature-mfnews-120440-In_May_MF_industry_lost_186_lakh_equity_folios.htm), “in May, MF industry lost 1.86 lakh equity folios”.
According to The Indian Express dated April 27 2012 (http://www.indianexpress.com/news/mutual-funds-lose-over-7-lakh-folios-in-six-months/942150/0), “mutual funds lost over 7 lakh folios (1.5%) during the six months ended March 2012”.
According to Business Standard dated July 26 2011 (http://www.business-standard.com/india/news/sebi-retractsunique-mutual-fund-folios/443847/), “the industry lost more than half a million folios during the period (June quarter), compared to the March quarter”.
According to Value Research article dated Nov 18 2010 (http://www.valueresearchonline.com/story/h2_storyView.asp?str=15593), “equity folios shrink by 3.52 lakhs in October”.
Reduction in equity folios, reduction in the earnings of brokerage firms, and reduction of STT collected (Economic Times – Aug 20 2012 – http://economictimes.indiatimes.com/news/economy/finance/securities-transaction-tax-mop-up-down-by-15/articleshow/15564395.cms) confirms the trend that retail investors are reducing their exposure to equity. And this not because of the charges levied by mutual funds or the government. It is primarily due to the fact that fixed income products and precious metals have performed better than equity.
An educated mutual fund investor will surely ask why he should pay more in expenses when the returns are lower than their benchmarks!
