Mutual Funds
Expense Ratio: Questionable practices of mutual funds

Recently, the Securities & Exchange Board of India allowed fund companies to charge more to investors through a convoluted formula. The practices of fund companies, anyways, were to charge more, not less because investors are usually blind to fund charges, being focused more on returns

The new rules announced by the Securities and Exchange Board of India (SEBI) at its recent board meeting allow asset management companies (AMCs) to charge a higher total expense ratio (TER) in order to increase the penetration of mutual funds. Investors, on the other hand, would have to sacrifice a portion of their returns for the business expansion, or rather benefit, of the asset management companies. According to the SEBI circular, “AMCs will be able to charge 30 basis points (bps) if the new inflows from these cities/towns are minimum 30% of the total inflows. In case of lesser inflows the proportionate amount will be allowed as additional TER.” The additional TER will be on the full fund corpus and not just only the fresh inflows. Instead for focusing on reducing costs SEBI has rather given AMCs the leeway to charge more from the investors.

But what has been the practice of fund houses when it comes to charging TER? As per the existing regulation, the TER which includes the management charges, marketing and selling expenses, brokerage costs and costs related to investor communications, audit fees, etc, cannot exceed 2.5% for equity schemes and 2.25% for debt schemes. In case of an index scheme or exchange traded fund, the total expenses of the scheme should not exceed 1.50%.

As per the new rules, AMCs would be able to charge up to a maximum of 30 bps additional. Fund companies usually disclose the maximum TER they would charge in the scheme information document and more often than not they quote the maximum permissible. Many fund companies charge much lower than the maximum suggested but it does not mean that what they charge for a particular month will be the same a few months down the line.

In fact, the maximum TER charged is already too high for debt and index schemes. Fixed income assets barely deliver returns slightly above inflation and from that if 2.25% is deducted it makes these schemes no better than bank fixed deposits. And the TER charged for index schemes is a total rip-off. All the fund manger needs to do is to invest blindly in the stocks according to their weightage in the index.

For liquid schemes; nearly 80% of the schemes charge a TER between 0.15% and 1%, which is a wide range by itself, but there are still a few schemes that have a TER above 1% and going up to 2.25%. Imagine for a scheme which returns just around 6%-8% per annum and out of that 1% to 2% is deducted by the fund company. For such schemes the return would work out much lower than a bank fixed deposit. Does it make sense to pay for such performance?

The actual TER of a scheme varies considerably and the fund company has to make a notification just two days prior before changing the TER. In fact a couple of years back SEBI observed that fund houses were frequently changing the expense ratios of liquid and short-term debt schemes. Most of the schemes highlighted by SEBI were of debt and liquid fund category. But since then nothing much has changed.

Since the start of the year as many 87 out of 211 equity schemes have changed their TER. 29 out of 74 income schemes have changed their TER and nearly half of the 57 liquid schemes have made changes to the TER.

One should not get fooled if the TER is much lower than the norm. There are many schemes which have had an initial TER which was substantially low but they have only gone to increase it a few months later. And this has been the case in all types of schemes. Edelweiss Equity Enhancer Fund from September 2009 to January 2011 had a TER around 1%. However from June 2011 onwards the TER has been as high as 2.49%. Imagine schemes from LIC Nomura MF, HSBC MF and JM Financial all of which run poorly managed schemes which have delivered substandard returns are charging the maximum TER of 2.5%. And some of the better managed schemes are charging a much lower TER.

Even if the TER is constant over a period, this does not mean the mean that the fund company cannot increase it. Take the case of Axis Equity Fund, it scheme was charging a TER of 1.79% in March 2010, over the next two years the TER has increased to 2.20%. Same has been the case with HSBC Unique Opportunities fund—in December 2008 the TER was around 2% and over the year it has increased to 2.5%. Over time one would expect their assets under management to increase and the TER would come down. But this has not been the case and the TER has increased over time.

These are just a couple of examples from equity schemes. For debt and liquid schemes it has been much worse. The fluctuation in the TER is much more and the fact that it can go up to 2.25% is a scary thought.

What can an investor do in such cases? Not much. It is the regulator’s job to resolve such discrepancies. The TER should be based on the performance of the scheme as well and not only the fund corpus. And the maximum TER charged should be made reasonable for the investor in the liquid and debt schemes. In order to revive the fund industry the regulator would consider increasing expense ratio, but this may mean greater leeway for the fund company to play around.

Take the example of index schemes—here the maximum TER allowed is 1.50% a percentage lower than that equity diversified schemes. Considering the low limit, fund companies do not play around much with the TER and it is usually around 1% to 1.5%. Therefore putting a reasonable limit fund companies either charge the maximum or a little lower. Hence, there is not much variance for the investor to get worried about.



Kolhe Jitendra Punjaram

5 years ago

I think it is enough talking about new reform. SEBI is not going to think on investor’s ways. Just focus on the existing regulation and take strong stance to follow them. Certainly the competitive advantages lead survivor of the performing AMC.

Prakash Chhotulal Patel

5 years ago

SEBI and AMC's think that mutual fund investors are fool.They ,themself are to blame for the diminishing interest of retail investors in MF's.After insurance companies which misled investors by ULIPs now is the turn of MF industry to face the scene of investors deserting MF

Harish Nagpal

5 years ago

It is quite strange that mutual funds are paying brokerage more than a normal Investors.Sebi has told them that they cannot pay more brokerge than .12% it means they are already paying more than that.It is quite intresting that a entry load was costing less to retail than the current as entry load of 2% amortised over five years is .40% in 5 years.But the incremental .30% on portfolio year on year will be much higher than 2% rather much much as if mkt doubles then it have very big affect.Further As per my understanding AMC charges are deducted on daily basis while they pay after one month .The float of money is so huge the income from that float should go to investors .

Sweena Jain

5 years ago

SEBI instead of taking care of INVESTORS is keen to take care of AMC's.SEBI always helps AMC's Brokers or other market intermediary.BUT NEVER FOR INVESTORS.


5 years ago

Sebi has only helped Mutual funds rip off investors even more

India’s GDP growth marginally higher in June quarter, says Nomura

The positive surprise in the Indian economy was mainly due to a higher agricultural GDP growth (bumper winter crop) and higher construction sector growth, says Nomura Economics Research about the second quarter of the year 2012

Real GDP growth rose marginally to 5.5% in second quarter of the calendar year 2012, from 5.3% in the first (March) quarter, which is above expectations (consensus: 5.2%, Nomura: 5.4%). The positive surprise was mainly due to a higher agricultural GDP growth (bumper winter crop) and higher construction sector growth (at 10.9% y-o-y), says a Nomura Economics Research Report on the subject.


Nomura warns however, that underlying demand remained weak. Fixed investment growth weakened (0.7% y-o-y in Q2 versus 3.6% in Q1) and export growth moderated (10.1% from 18.1%). By contrast, import growth picked up (7.9% from 2.0%). Government spending also accelerated (9%)—a mirror of the ongoing fiscal slippage which is clearly crowding out private investment, says Nomura. Private consumption growth weakened sharply to 4% y-o-y in Q2 from 6.1% in Q1, likely because of sluggish income growth and still-elevated inflation, says Nomura.


On the supply side, apart from the positive surprise in agriculture, services GDP slowed sharply to 6.9% in Q2 from 7.9% in Q1, which reflects lagged effects of the industrial slowdown, observes Nomura.


Overall, despite today’s slightly higher GDP, Nomura believes that the underlying growth momentum remained weak with three critical drivers: private consumption, investment and exports leading the slowdown.


Early data for the third quarter such as the manufacturing PMI (purchase managers’ index) and exports suggest no pick up in sight.


Nomura expects real GDP growth to remain around 5.5% in the third quarter, with overall growth of 5.8% in FY13 (year ending March 2013), lower than 6.5% in FY12.


Brace for a correction in the stock market, warns BNP Paribas

BNP Paribas’ Market Outlook report says that recent outperformance in the stock market seems to be based on hopes of policy implementation. But such hopes seem to be getting continuously postponed, and 2012 has been a year of “shifting milestones”

BNP Paribas Securities India’s Market Outlook Report says that the ongoing correction in the stock market is likely to continue. While the Indian market is one of the best performing equity markets among Asian and Emerging markets this year, recent outperformance seems based on hopes of policy implementation. But such hopes seem to be getting continuously postponed. 2012 has been a year of “shifting milestones”. At a 12-month forward PE (price-to-earnings ratio) of 13.6 times the Sensex is neither cheap nor expensive (long term average is 15.2 times). Historically, the Indian market bottomed out at 12-12.5 times and the market is about 10% higher than those levels. Overall, BNP Paribas warning is to “brace for a correction” in the market.


On the demand side, BNP Paribas observes that the monsoon have improved, but consumption weakness is becoming apparent. The rainfall-related concern seems to be getting behind us post-massive monsoon precipitation in north and north-west India since mid-August. The current all-India monsoon deficit (-13%) presents a much better picture than in early July (25%-30%).


There are initial signs of declining demand in consumer discretionaries—particularly two-wheelers. This is clearly worrying because consumption seems to be the only leg that the Indian economy is running on, warns BNP Paribas. Even in the property sector smaller unlisted developers have begun to default on their loans to banks, as BNP Paribas channel checks reveal.


On the price side, BNP Paribas warns that liquidity injections could keep the market buoyant for a while. Predictably the high beta sectors—banks, metals, property, auto and engineering—tend to outperform. The best portfolio stance to balance the possibilities of domestic disappointment and global liquidity injection seems to be a “feet in two boats” approach.


BNP Paribas sector recommendations include downgrade of the automobiles sector to neutral, upgrade of IT sector to overweight and increase weight on the pharmaceutical sector Also, the recommendations include overweight on pharmaceuticals, engineering, utilities and IT services sectors. BNP Paribas is neutral on automobiles, telecom and energy. Finally, the lower side recommendation is underweight on consumer staples, banks and metals, says BNP Paribas.


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