• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

Suresh Krishnamurthy

Expenses charged to mutual fund income schemes continue to be high. And the returns from income schemes could get substantially lower if expenses are not reduced. Distributors and asset management companies need to reduce costs if they seek continued investor patronage.

THE continuing fall in interest rates for the six-month period ended September 30 has kept high expense ratios from denting returns earned by debt mutual funds. However, the end of the road may well have been reached. The next half-year could force asset management companies to reduce expenses charged to the schemes. If they don't, it could reduce returns sharply for the investor.

The onus is now on the mutual funds to resolve the issue as speedily as possible. If they do not, investing in the income schemes of mutual funds will itself not make sense for investors. Importantly, there may be no opportunity for investors to shop for low-cost diversified income schemes. All of them uniformly charge about 1.5 per cent or higher.

High expenses: Expense ratios measure the charges made against the income earned by mutual fund schemes. These reduce the returns earned by the schemes for the investor. For the six-month period ended September 2003, average expenses for 15 major debt schemes were about 1.72 per cent of the average weekly net assets.

This is virtually identical to the average expense ratio of 1.74 per cent for the six-month period ended March 2003. The only difference is that schemes have generated better returns of about 7 per cent during the six-month period September 2003 compared to about 6 per cent in the six months ended March 2003.

It could get tougher to generate competitive returns if interest rates remain stable. The indicative yield to maturity of income schemes is now at about 5.25 per cent. If costs of 1.5 per cent were charged to schemes, the pre-tax returns would be about 3.75 per cent. Post-tax, returns would be about 3.4 per cent. Compare this with the 6.5 per cent tax-free returns provided by RBI Relief Bonds now.

Mutual funds say that if contractual rates administered by the Government were reduced, these returns would still be competitive. However, that does not mean mutual funds need not cut costs or there is no scope to cut costs. The costs charged to mutual funds are predominantly distribution costs, those that are incurred to increase the size of their business.

Mutual funds desire to grow their business, which is not wrong. However, to ask the investor to fund their expansion plan partially is wholly unfair. In this context, it is now time for mutual funds to persuade distributors, who are now blamed for the high costs, to reduce their commissions.

Shopping impossible: Normally, in countries such as the US, the costs charged by various funds vary a lot. It is possible to shop for funds with good performance that charge low costs. However, such shopping for low-expense ratios is not rewarding in India. Uniformly, all funds charge 1.5-1.7 per cent. In addition, the ones that charge slightly lower are not exactly superior performers. Floating rate funds are an option especially since interest rates appear to have bottomed out. However, Templeton's Floating Rate Income Fund — long-term option, charges as much as the normal income schemes, by way of expense ratios. Floating rate schemes floated by Birla and Grindlays charge less than one per cent. They can be considered for investment.

Another scheme that catches the eye is Birla Bond Index Scheme. The scheme's performance has been inferior to other funds so far. However, it charges costs of less than one per cent. At a time when the scope for large decline in interest rates appears limited, it might just be difficult to outperform this scheme if costs are as low as they are now.

If established asset management companies launch similar Bond Index schemes, they are also likely to be attractive, if they too promise to cut costs.

Otherwise, mutual fund income schemes are increasingly turning unattractive. With interest rates stabilising there is bound to be greater pressure on funds to reduce expenses. Therefore, investors can wait for another half-year before deciding if they should reduce their exposure to these high-expense charging diversified income schemes.

Article E-Mail :: Comment :: Syndication

Stories in this Section
Tyres: Punctured by high input costs

Copyright © 2003, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line