Expense ratio may not hurt that much

    Aarati Krishnan
    BL Research Bureau
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Investors in equity funds with a good record need not worry too much

U.K. Sinha, Chairman, SEBI addressing a press conference in Mumbai on Thursday, 16-8-201. - SHASHI ASHIWAL
U.K. Sinha, Chairman, SEBI addressing a press conference in Mumbai on Thursday, 16-8-201. - SHASHI ASHIWAL

Slightly higher costs for equity fund investors, higher ongoing commissions to distributors and a possible boost to the profit margins of fund management companies — these could be the implications from the host of decisions taken by SEBI on Thursday to re-energise the mutual fund industry.

The higher cost to investors could arise from two factors. First, the decision to allow funds to pass on service tax on fund management to investors, instead of absorbing it. A service tax of 12.6 per cent is currently charged on the fund management fees (1.25 per cent of assets) of mutual funds. This service tax will now be passed on to investors in funds.

Difficult task

Two, the new leeway to allow funds to charge an extra 0.30 per cent of assets as expenses, if they get sizeable inflows from outside the top 15 cities. Overall, if funds avail of both these relaxations, their expense ratio may rise from the current maximum of 2.5 per cent to about three per cent of their average net assets. But as getting 30 per cent of incremental inflows in equity funds from outside the top cities will prove a difficult task, not many schemes may be able to take this leeway.

The move to allow all funds to raise their total expense ratio by 0.20 percentage points, which has also been granted, may be mostly offset by the fact that exit loads charged by funds will now be treated as the scheme’s income. With exit loads coming back into the scheme, investors who stay with a fund will benefit when others make an early exit.

Overall, however, investors in the equity funds with a good performance record need not worry too much about the expense ratio tweaks. This is because top-performing funds in India tend to beat the index as well as peers by a large margin.

The top-performing equity fund over the last five years, for instance, delivered a 13 per cent annualised return. That is 11 percentage points more than the Sensex return of two per cent.

While the best fund made a 13 per cent return, the worst equity fund has lost about seven per cent a year in value over the last five years. Both these facts show that investors in equity funds should go for better performers even if this means shelling out a few basis points more in expense ratio.

The higher expense ratio is not likely to impact debt funds immediately as competition in this space tends to keep expenses much below regulatory limits.

(This article was published on August 16, 2012)
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