SEBI Reviews Total Expense Ratio (TER) of Mutual Fund Schemes after 22 years; what's in store for investors?

Capital markets regulator Securities and Exchange Board of India (SEBI), after 22 years revised the total expense ratio (TER) of mutual funds. In an attempt to reduce mis-selling and costs, the capital market regulator revised the TER in a board meeting on 18 September. The slab wise limits of TER introduced under SEBI (Mutual Funds) Regulations, 1996 have not been changed since then. “For starters lower expenses would translate into better returns for the investor. This would increase transparency as all scheme expenses are to be made public”, said Ganti Murthy, senior fund manager and fixed income professional.  

 

The Assets Under Management (AUM) of mutual fund industry in India has grown manifold over the years. As on August 31, 2018, the AUM of the industry has crossed Rs 25 lakh crore.

SEBI is of the view that while the AUM has grown multiple times, the benefit of economies of scale has not been fully shared with the investors. It is also observed that over a period, there have been varying practices in the industry with respect to charging of expenses and payment of commissions.

 

SEBI undertook an internal study to review the TER.  The analysis along with observations of the study was placed in a meeting of the Mutual Fund Advisory Committee (MFAC). The working group constituted by MFAC deliberated on the issues and submitted a report to MFAC. Upon deliberation on the findings of working group, MFAC made several recommendations on transparency in expenses, TER for various types of mutual fund schemes, investments through SIPs, limiting the additional incentives for B-30 cities based on inflows from retail investors, performance disclosure of Mutual Fund schemes, etc.

 

Accordingly, the Board approved the following proposals:

Transparency in Expenses:

SEBI has not only reviewed the TER but it also stated about the distributors compensation. The regulatory body mandated that all commission and expenses, etc. shall necessarily be paid from the scheme only and not from the AMC/Associate/Sponsor/Trustee, or any other route.

 

Further, the mutual fund industry must adopt the full trail model of commission in all schemes without payment of any upfront commission or upfronting of any trail commission. An upfront commission is a fee a customer pays to a distributor for investing in a mutual fund scheme. While the commission is meant to incentivize distributors to bring in new investors, there is a fear that distributors may mis-sell products or make existing investors churn their portfolios unnecessarily to earn higher commissions.

 

A carve out has been provided for upfronting of trail commission in case of SIPs subject to fulfilment of certain conditions.

 

Association of Mutual Funds in India (Amfi) in April 2015 urged the AMCs in India to cap the maximum rate of upfront commission at 1% and the total payout to distributors, including trail commission, at 1.75% for every year during the life of a mutual fund scheme. While upfront commissions are paid by AMCs to agents on the sale of a product, trail commission is paid through the life of a scheme.

 

An Amfi code of conduct says that extra commission or incentive should never be the basis for recommending a scheme. The SEBI recent decision may impact the mutual fund sales as commission is an incentive for the distributors. “Regular plans still form a major chunk of mutual fund inflows and without upfront commissions not many distributors would opt to sell mutual funds and would shift to other products”, said Murty. Moreover, this may also stop the practice of unnecessary churning and redemptions in mutual fund portfolios and help in increasing the investment tenure in the fund.

 

TER for open ended schemes shall be as follows:

 

AUM Slab (INR crore)	TER for equity oriented schemes	TER for other schemes (excl. Index, ETFs and Fund of Funds)
0 -500	2.25%	2.00%
500-750	2.00%	1.75%
750-2000	1.75%	1.50%
2000-5000	1.60%	1.35%
5000-10000	1.50%	1.25%
10000-50000	TER reduction of 0.05% for every increase of 5,000 crore AUM or part thereof	TER reduction of 0.05% for every increase of 5,000 crore AUM or part thereof
>50000	1.05%	0.80%

 

TER for Close Ended and Interval Schemes:

 

TER for equity-oriented schemes shall be a maximum of 1.25% and for other than equity oriented schemes shall be a maximum of 1%.

 

TER for Index schemes, Exchange Traded Funds (ETFs) and Fund of Funds:

 

a)     Index Funds and ETFs: The TER shall be a maximum of 1.00%.

b) Fund of Funds (FoFs): The TER of FoF scheme, shall be a maximum of twice the TER of the underlying funds.

 

i) FoFs investing primarily in Liquid, Index and ETF schemes: Total TER (including the TER of underlying schemes) shall be maximum of 1.00%

 

ii) FoFs investing primarily in active underlying schemes: Total TER (including the TER of the underlying schemes), shall be maximum of 2.25% for equity-oriented schemes, and maximum of 2% for other than equity-oriented schemes.

 

Additional expenses of 30 bps for penetration in B-30 cities:

 

AMCs usually pay higher upfront commission on business from B-30 cities. The commissions are higher by 1% to 1.5%. But the market regulator Sebi has now said that the additional expense permitted for penetration in B-30 cities, shall be based on inflows from retail investors. The definition of ‘retail investors’ shall be determined in consultation with the industry. Pending such clarification, the additional incentive shall be permitted for inflows from individual investors only and not on inflows from corporates and institutions. Further, the B-30 incentive shall be paid as trail only. “Fund houses would be affected as their business plans go for a toss”, added Murty.  

 

SEBI also asked the fund houses to provide adequate disclosure of all schemes’ returns (category wise) vis-à-vis its benchmark (total returns) shall be made available on the website of Amfi          .

 

The Board proposals were based on to provide benefits with respect to sharing of economies of scale, lowering the cost for mutual fund investors, bringing in transparency in appropriation of expenses, and reducing mis-selling and churning. Although, SEBI has reduced TER, at the same time it has also banned upfront commissions and asked the industry to adopt the full trail model of commission in all schemes which are obligatorily to be charged to the schemes. So, overall it might not translate into better returns for the investors?