Sebi’s rules: Gain some, lose some

Find out how the market regulator’s recently issued guidelines for the mutual fund industry will impact your investments

The mutual fund landscape in India is undergoing rapid changes. The industry watchdog, Securities and Exchange Board of India, has ushered in a whole new framework for this investment avenue primarily to help revive a flagging industry. While industry players scurry to deal with the revised guidelines, fund investors need to be aware of the manner in which these steps will impact their investments. Will you need to alter your strategy due to these? Here’s what the new regulations mean for you.

Hike in expense ratio

Sebi has allowed asset management companies (AMCs) to charge an additional expense ratio of up to 0.3% on the daily net asset value (NAV) of the scheme, if the net inflows are received from locations beyond the top 15 cities. AMCs will be able to charge this extra total expense ratio (TER) if the AUM collected from these places is more than 30% of the gross inflow. In case of lesser inflows from smaller cities, the proportionate amount will be allowed as additional TER. There is, however, a provision of reclaiming the additional TER charged if the money is redeemed within one year from the date of investment. Also, until now, the service tax charge on your scheme was borne by the mutual fund company. However, Sebi has now ruled that this will be passed on to the investors.

How it impacts you

The additional TER will be charged on the entire scheme corpus, not merely on the fresh inflows. So, Sebi is essentially asking the investors from the top tier cities to directly bear the cost of getting tier II cities’ investors into the mutual fund fold. A 30 basis point (bps) increase in expenses can hurt your returns over the long term, especially if your scheme is not among the top performing ones. For the schemes that consistently underperform their benchmarks, this extra levy will be an added burden. Along with the service tax, these moves are expected to add around 0.4% to the cost.

Single plan structure

The regulator has mandated that all schemes should be offered under a single plan. All existing schemes with multiple plans based on the amount of investment will now have to accept subscriptions only under one plan.

How it impacts you

This means that all investors in a particular scheme will be subject to the same expense structure. This will do away with differential treatment for various categories of investors, and will also lead to a sharper focus on the fund manager. It also means that certain plans may be discontinued in favour of others. Some funds have chosen to stick with the retail option, while others have opted for the institutional plan. However, in the cases where the institutional plan has been chosen, the fund houses have brought down the minimum investment amount. The discontinuation of plans will not affect the existing investments made by people in these plans and they can redeem their holdings any time. “This single plan structure has affected debt fund investors more as hardly any equity schemes are offered under multiple plans,” points out Srikant Meenakshi, director, FundsIndia.

Direct plan route

While Sebi has done away with multiple plans under the same scheme, it has announced that each scheme will offer an equivalent direct plan. This plan will have a separate NAV, different from the normal scheme.

How it impacts you

A separate direct plan will take out a chunk of the cost a normal fund scheme has to bear towards the payment of distributor commissions. It is likely to take up to 0.75% of the expense ratio, which means a higher NAV and better returns for investors over time. If you are comfortable enough to make investments without the need of an adviser or broker, you can shave off a significant portion of the cost by buying from the AMC directly. However, it will be your responsibility to choose the right type of fund, physically approach the nearest branch of the fund company to buy the same, monitor the performance and complete the redemption formalities. When you choose to go with an adviser, all these activities are taken care of for you, even though you have to cough up the extra 0.5-0.75%.

Exit loads

Most mutual funds charge an exit load if you redeem fund units within a year of investment. Earlier, the amount earned through exit loads was used by the AMC for marketing and distribution. However, Sebi has now ruled that the entire exit load will be credited back to the scheme corpus. It has also stated that an equal amount (capped at 20 bps) can be included in the expense ratio to compensate the fund company for loss due to outgoing investors.

How it impacts you

The rationale behind this move is to ensure that the existing investors will no longer be hit when others redeem their investments early. However, as the regulator has simultaneously allowed fund companies to levy an equivalent charge as compensation for the outflow, the net effect remains the same.

Defining advisers

The regulator has defined the role and responsibilities of an investment adviser by enforcing a minimum qualification. From now on, all advisers, as defined by Sebi, will have to register with it and conform to the new regulations. They will only be allowed to charge clients a fee for their service and will not be eligible for commissions from companies on sale of products.

How it impacts you

These measures should usher in more transparency in the advisory services and help clients distinguish genuine advisers from product pushers. Since the adviser can now earn a fee from you but no commission from the AMCs, mis-selling may come down to an extent. The minimum certification, if properly designed, should also ensure quality of advice.

Other measures

• Small investors, who may not be taxpayers or have PAN and bank accounts, will be allowed cash transactions in mutual fund schemes up to 20,000.

   

• The regulator will evolve a system of product labelling, that is, a categorisation mechanism that should help investors understand the different types of funds sold.

   

• Internal limits in expense ratio have been removed and these will let fund companies allocate expenses in the manner they deem fit, within the overall cap. It is likely to lead to more aggressive promotional activities and higher distributor commissions.

• Mutual funds have to annually set apart at least 2 bps on daily net assets within the maximum limit of TER for investor education and awareness initiatives.

The verdict

The most noticeable impact of the recent changes is that the investors will have to bear a slightly higher cost for investing in mutual funds. But while there is an added burden on investors, there are some things to cheer about. The introduction of the cost-effective direct plan, credit of exit load back into the scheme, product labelling for simplifying fund selection, and implementation of more strict investment advisory regulations are welcome from the investors’ point of view. Meenakshi says, “These regulatory changes have not changed the investment proposition in any way. Mutual funds remain the most prudent vehicle for building wealth.”

The good...

• Exit loads ploughed back into the scheme.

• Direct plans, with a lower expense ratio, will be offered.

• Product labelling will simplify fund selection.

• Tighter investment advisory regulations.

The bad...

• Higher expense ratio on all schemes if inflows are from cities other than the top 15.

• Service tax to be borne by investors instead of the fund company.

Courtesy:
Sanket Dhanorkar
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