Entry load or AMC may be asked to bear the burden

Veena Venugopal

Existing practice

Fund houses

, currently, can charge up to 6 per cent of its collections as issue expenses.

The sum

can be amortised over a period of five years.

Mumbai, March 20

The concerns of long-term investors of mutual funds about bearing the initial issue expenses may finally be put to rest.

The Securities and Exchange Board of India (SEBI) would be soon issuing new guidelines for fund houses, suggesting that the issue expenses be made part of entry load for all open-ended funds. If the fund house does not wish to do so, the expense would have to be absorbed by the asset management company.

Existing norms

As per the existing guidelines, fund houses can charge up to 6 per cent of its collections during new fund offers as issue expenses. This indicates that if a fund collects Rs 5,000 crore, up to Rs 300 crore can be charged as issue expenses.

This sum can now be amortised over a period of five years.

Investors to the fund, especially long-term investors, end up paying for the marketing extravaganza of the fund house to publicise its New Fund Offer (NFO).

With funds mopping up larger sums during the NFO, on the back of mega advertising campaigns and high brokerages to distributors, amortisation of issue expense was seen as an issue of concern by the Association of Mutual Funds in India (AMFI). Subsequently, AMFI had sent its recommendations to SEBI.

Board meeting

The capital market regulator is understood to have discussed the issue at its board meeting today and is likely to come out with a new set of guidelines shortly.

The ambiguity of this method of accounting for the issue expenses is made worse by the fact that the net asset value (NAV) of the fund does not take these expenses into account, immediately after the closure of the NFO. While the AMC may declare an above par NAV, the investor is not made aware of the fact that the fund would write off one-fifth of the issue expense at the end of the first year, thereby triggering a drop in the NAV. Also, investors who choose to stay invested in the fund end up absorbing a larger share of the issue expense.

AMFI's recommendation to SEBI also highlighted the fact that while several fund houses have raised large sums of money through NFOs, the incremental inflows into equity funds have not been very high.

This indicated that distributors were getting investors to move from existing fund to NFOs to net higher brokerages.

Some fund houses pay between 4 per cent and 5 per cent as brokerage to distributors during NFOs, resulting in mis-selling of funds.

Related Stories:
Initial expenses: How aware are we?
Who pays for new fund expenses?

(This article was published in the Business Line print edition dated March 21, 2006)
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