Mutual funds may not have made people like you and me a lot of money in FY19, but the year did give us retail investors plenty of reasons to rejoice. The good times have now rolled on in FY20 as well. After setting the house in order with regard to distributor commissions and clear equity market cap and bond portfolio categorisation of investments, mutual funds are now all set to lower the cost of investing.
After a gap of nearly a decade, FY20 will see a major overhaul in the fee or the Total Expense Ratio (TER) Mutual Funds charge to investors for managing and investing money. The move, which has come into effect from April 1 this year, flows from market regulator SEBI’s diktat on TERs issued in October 2018. The cost of investing will come down across the board – for open-ended and close-ended funds in both the equity and debt category. The drop may be 12-15 percent in the equity category resulting in total investor savings of almost Rs 2000 crore, according to some industry estimates. The changes will impact large funds with big assets under management (AUMs) the most. That’s because they will have to slash their fee as size grows.
According to the new rules, funds which have a small corpus can charge investors a higher fee. In fact, open-ended equity funds with AUM of less than Rs 500 crore can charge the max TER of 2.25 percent. The amount of fee funds can charge drops slab-wise as the AUM increases. This is illustrated in the table below:
It's interesting to note that as a fund crosses Rs 15,000 crore AUM it will have to drop its TER to 1.45 percent. When its AUM rises above Rs 20,000 crore, it will have to lower the expense ratio by another 0.05 percent to 1.4 percent. Finally if the fund’s size balloons to over Rs 50,000 crore, it will only be able to charge a maximum fee of 1.05 percent.
This new regime has some important ramifications for large-sized funds. Many such funds are in the balanced fund or hybrid fund category. Feroze Azeez of Anand Rathi Wealth says balanced funds which had rapidly increased their corpus with the promise of monthly dividends will take the biggest hit on the cost front. “Balanced funds and equity-oriented hybrid funds may see a 25 to 37 basis point fall in TER – the highest in the industry,” says Feroze.
According to Anand Rathi’s calculations, the HDFC Balanced Advantage Fund is likely to see the biggest fall of almost 0.37 percent in the Total Expense Ratio or TER. Next in line could be the SBI Equity Hybrid followed by the ICICI Prudential Equity and Debt Fund. Interestingly, Azeez has a sell recommendation on all three funds despite the big fall in fees. “Cost is only one factor. Returns, risk profile and tax efficiency are the other, bigger attributes on which we must evaluate a fund,” points out Azeez.
The table below highlights the 10 funds likely to see the biggest fall in cost in the new expense ratio regime:
While the fall in cost can’t and shouldn’t be the only determining factor in your decision to invest in a fund. The reduction in TER is a welcome move as it gives mutual funds a healthy competitive edge vis a vis ULIPs which enjoy a more favourable tax regime. ULIPs carry a lower fund management fee compared to mutual funds, but they do come with additional levies like mortality charge, policy administration charge and premium allocation charge. “The fall in MF expense ratios is a timely move. It will keep mutual funds competitive vis a vis ULIPs despite the disadvantage of the Long Term Capital Gains tax levied on MFs” says Personal Finance expert Hemant Rustagi.
ACTIVE OR PASSIVE?
The fall in TERs of actively managed funds is also important considering the strides being taken by the passive fund industry. Though still nascent and minuscule in size compared to active funds, passives made their presence felt all through 2018 by handsomely beating active fund returns. This happened simply because the benchmark index outperformed broader markets thanks to select large-cap stocks.
The new norms cap TERs for passively managed index funds and ETFs at 1 percent. However, this is not of much consequence as passive funds already charge a much lower fee than the prescribed cap. In fact, passive funds can charge as little as 0.4 percent since there is no active management of money involved.The fall in TERs is perhaps a sign of the Indian fund management industry maturing. Despite market volatility, SIP flows have remained strong and fund managers are confident that overall flows into equity funds will pick up as the market sentiment improves. A fall in cost at this juncture gives retail investors another reason to keep their faith in financial investments and create long term wealth by participating in India’s growth story.