Impact of costs: In most developed countries low-cost debt funds are also the debt funds that fetch higher returns. Given that interest rates have dropped sharply to levels below 6 per cent, that would be the case with Indian funds too. This is because costs, as a proportion of returns generated by a portfolio, are high.

Annual costs of 1.5 per cent of portfolio assets work out to nearly 25 per cent of the probable 6 per cent returns that a portfolio can generate. This state of affairs already makes out a case for lowering costs charged by debt funds and unit-linked insurance plans.

The case is even more so for long-term debt investing. Suppose you invest Rs 100,000 each year in a mutual fund and the fund charges 1.5 per cent per annum as expenses. The costs charged increases from Rs 1,500 in the first year to Rs 29,800 in the 15th year — nearly 20 times the fee charged in the first year.

In unit-linked insurance plans too, the rise in fund management costs is similar. The sum of Rs 29,800 does work out to 1.5 per cent per annum of the portfolio value after 15 years. But is it necessary? How can the fees for managing a portfolio rise in such a linear fashion? When applied to the value of net assets of Rs 1,000 crore, which could go on to a size of Rs 15,000 crore or more after 15 years, the amounts charged would be astronomical and wholly inappropriate for managing a portfolio.

Fund managers do need incentives for delivering returns. In addition, competition will bring down costs over the next 15 years. As such, the regulator need not do anything now.

On the other hand, it is also possible that mutual funds, which come together under an association, can uniformly decide not to reduce costs. In this context, it may be in the fitness of things if the present cap on costs is reduced further.

Revising the cap: Applicable regulations now cap costs at 1.5 per cent of assets under management in excess of Rs 700 crore for schemes investing in bonds. Schemes have, however, long sailed past the threshold of Rs 700 crore. For instance, at the end of March 2004, HDFC Income fund had Rs 2,500 crore of assets under management.

Similarly, Prudential ICICI's Income Plan had Rs 1,700 crore and Templeton India Income Plan had Rs 1,500 crore. As mutual funds become more popular, the assets under management will only swell to even higher levels. There is thus a clear case for revising the cap. For instance, assets under management in excess of Rs 1,000 crore should probably attract a cap of 0.75 per cent. Such a lower cap should at least be made applicable for funds marketing their products as a long-term proposition.

Close-end funds: There is also probably a case for introduction of close-end debt funds. Morgan Stanley came out with a 15-year close-end equity fund in 1994. None, however, has launched such a close-end debt fund.

Such a long-term close-end debt fund makes more sense than equity funds. Investors, however, have been kept waiting by fund houses. Close-end funds are more amenable to lower costs.

For investors bred on a staple diet of fixed deposits and in a land where even 25-year deep discount bonds have proved popular, 10-year and 15-year close-end funds do make sense. Cost caps for such funds could be made more stringent. But will fund houses relent and launch such funds?

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