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Suresh Krishnamurthy

Though asset management companies are beginning to enjoy economies of scale as fund sizes keep rising, there has been no reduction in costs charged to income schemes. This can invite the regulator's wrath. It would be better if the funds themselves set things right than let the regulator step on to their turf.

THE time of reckoning has arrived. Costs charged to mutual fund income schemes are now eating up the returns earned. There is a dire need for asset management companies to reduce costs. Mutual funds are, however, sitting tight.

Even as asset management companies jostle with each other to take a share of the investor's wallet, they are unanimous that costs will not come down significantly in the near future.

Funds appear to be placing their bets on a reduction in administered interest rates on smal-savings schemes. That would make income schemes attractive on an after-tax basis.

Yet, it would be in the long-term interests of funds if costs were reduced now. They would be seen as an investor-friendly move and, besides, it would ensure that the regulator does not force the issue down their throats. It is time funds opted for self-regulation.

Feeble arguments: The call for a reduction in costs has another dimension. Asset management companies have seen their profits swell handsomely in the first half of this year.

If profits are surging, are not investors justified in asking for a reduction in costs? After all, investors did not grumble about costs when debt funds were delivering double-digit returns.

Returns from mutual fund schemes now threaten to decline below 5 per cent necessitating a reduction in costs.

Mutual funds, however, argue that asset management companies are not earning abnormal profits. This is true.

As of March 2003, return on net worth of asset management companies ranged between 10 per cent and 15 per cent in most cases. However, profits are rising now. If mutual fund profits rise 70 per cent this year, their return on net worth will rise to nearly 20 per cent, on an average. Importantly, this is just the beginning. Mutual funds appear poised to take a bigger share of the market for bank term deposits.

They could easily service the income fund asset base that is twice or thrice the present level without any substantial increase in costs.

Now, that would lead to a substantial rise in profitability and sustained profit growth over a long period. In this context, a demand for reduction in costs is justified, taking into consideration the steady annual rise in funds under asset management.

Another argument is that reduction in fees will lead to a reduction in quality of service, as it would be impossible to compensate skilled managers. However, it is not compensation of analysts that is behind the high cost structure.

Brokers, whose value addition is quite little when compared to the service provided by the asset management companies, are earning as much as the asset management companies. This cannot continue. Fixing this issue alone will reduce the costs charged to income schemes.

Besides, investors are not demanding a reduction in costs charged to equity schemes. Cost reduction is demanded only in the case of income schemes, where the economies of scale have been proven. The scale economies are continuing to improve profitability.

Mutual funds are also planning to utilise the benefits in the form of increasing the salary of managers and improving the distribution infrastructure. However, using the benefits to reduce costs should be the first priority.

Self-regulation: The mutual fund industry is a competitive market. However, the competition in the industry has taken an ugly turn for some time now.

Asset management companies are vying with each to appease the broker, who is the conduit to the investor's wallet. Instead of investor interest, it is the broker's interest that is now being taken care of.

From the companies' perspective this might make sense. However, this is only going to invite the wrath of the regulator sooner or later.

Allowing the regulator to step in will also set up an unnecessary precedent.

This would ensure that the regulator will step in and cap the costs every time the asset size grows beyond a particular level. That may not be desirable at all.

As such, if through self-regulation, the mutual fund industry can ensure that costs are reasonable, it would suit the interests of all concerned.

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