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Suresh Krishnamurthy

AT A time when the returns generated by mutual fund income schemes are declining sharply, their expense ratios are proving to be sticky. With bond portfolios expected to earn about 6 per cent over a year, the high level of expenses could plunge one-year returns from mutual fund income schemes to below 5 per cent.

Far more worrying is the favour to institutional investors rendered by the asset management companies. In the case of income funds run only for institutions, expenses are considerably below what is charged to retail investors. The relatively lower expenses are justified. But the extent of difference is disturbing.

These retail investor inimical practices will change only if competition flourishes. However, there are no signs of competition pushing down expenses although there are more than 15 asset management companies to choose from. The result is that the utility of income funds is declining fast for retail investors.

Sticky expenses: In the half-year ended March 2003, expense ratios were between 1.5 and 2.0 per cent for most funds. This is almost the same as what was charged to the income funds in the half-year ended September 2002. During the same period, returns from income funds declined 20-25 per cent.

Expense ratios measure the expenses incurred by the asset management companies to earn income for the investors. Higher expense ratios affect the returns generated by the mutual fund scheme. At about 1.5 per cent, expenses would account for about 25 per cent of the returns generated by bond portfolios in the next year.

Such a high level of expenses is inimical to the performance of a mutual fund income scheme. The returns on from the scheme will, then, more likely resemble that of a shorter-term bank deposit.

Perhaps we are looking for a decline in expense ratios much earlier than warranted. Returns for the half-year ended March 2003, even after such high expenses, were about 6 per cent.

Asset management companies probably feel that it is appropriate to charge higher expenses when the returns are high. When half-year returns decline to about 3 per cent as may happen in the next six months, asset management companies may automatically bring down expenses.

Currying to institutions: In contrast, institutions are having a better time. Expenses charged to institutional plans for the half-year ended March 2003 range between 0.9 and 1.15 per cent — about 60 per cent of what is charged to income funds.

Lower expenses to institutions are normally justified. They bring in money in crores. Managing them, therefore, would prove less expensive. However, there is one catch. The lower expenses in the half-year ended March 2003 do not appear justified. This is because the size of the retail plans is far bigger than that of institutional plans for most asset management companies.

For example, the size of IDBI-Principal Trust Benefit Fund, scheme for institutions, is Rs 20 crore whereas the size of IDBI Principal Income Fund, plan for retail investors is Rs 561 crore. Similarly, the size of Templeton India IBA for retail investors is Rs 1,477 crore while the same plan for institutions has Rs 217 crore under management.

With such large assets under management, expenses charged to retail plans should perhaps not be significantly higher than what is charged to institutional plans. However, retail plans continue to be charged higher expenses. The result — institutional plans are outperforming retail plans. This is evident across various periods — 14 days, 1 month and 3 months.

Lack of competition: There is only one reason for low expenses in the case of institutions — competition, and not ease of management. Institutions demand lower costs and there is intense competition for their funds.

Asset management companies are luring the institutions with low costs even though the size of the institutional plans may not warrant it.

In contrast, the unorganised retail investors cannot demand low costs. They are therefore stuck with high costs. If this practice continues then the utility of income funds, the most tax-efficient option in the market, will be eroded. Investors will have less and less reason to invest more in income funds— the costs will outweigh the benefits.

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