Breathing life into funds

It is just as well that the Securities and Exchange Board of India (SEBI) is evaluating measures to resuscitate a flagging mutual fund industry. There is need to increase retail participation in the equity markets, and mutual funds are a good vehicle . A major reason for the stagnating investor base of mutual funds — lacklustre markets apart — is distributor apathy. Ever since the market regulator banned entry loads and forbade payment of agent commissions out of investor monies, mutual funds have been waging an unequal battle with other investment options.

It is in this context that SEBI’s mutual fund advisory panel has come out with new suggestions aimed at striking a balance between investor and distributor interests. For one, it has recommended that mutual funds be provided ‘fungibility’ on their total expenses. Current SEBI regulations not only place an annual limit on recurring fund expenses as a percentage of assets, but even specify how much of it should be spent on investment manager’s fees, marketing costs, and so on. While an overall expense ceiling helps protect investor interests, dictating beyond that amounts to needless micro-management. The proposed fungibility will allow fund houses to peg up distributor incentives without raising the overall cost to investors. The decision not to bring back entry loads – though competing avenues such as insurance do offer upfront commissions – is also wise. In an industry where investors can buy or sell units on a whim, unlike in insurance, the phenomenon of upfront commissions only encourages distributors to advise clients to frequently churn schemes.

While there is a strong case for improving the fundamentals of the asset management business, SEBI must, however, reject the panel’s recommendation for a blanket increase of 0.25 percentage points (calculated on the value of assets managed) towards defraying expenses and providing for a return on investment. The argument about the 2.5 per cent limit being set in the mid-nineties and the cost of hiring fund management talent, among other things, having gone up significantly since then, ignores a fundamental fact: The mutual fund business is immensely scalable and assets managed by the top equity schemes have risen from an average Rs 500 crore in the nineties to Rs 8000-9000 crore now. That’s why leading fund houses managing significant equity assets today, don’t require any concessions to generate a profit . A better way to ensure that smaller fund houses too compete effectively would be to widen the slab structure to permit larger payout towards expenses. Equity funds can now charge 2.5 per cent as expenses on the first Rs 100 crore of assets, 2.25 per cent on the next Rs 300 crore, 2 per cent on the next Rs 300 crore, and so on. This can well be tweaked to allow the 2.5 per cent expense ratio on schemes of, say, up to Rs 500 crore size, while setting lower limits beyond that. It would give smaller fund houses more leeway in managing expenses, without imposing higher costs for a majority of investors. That would be a win-win for both distributors and mutual fund investors.

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