Why These 5 Proposals By SEBI May Change Mutual Funds

A proposal presented by the Securities and Exchange Board of India (SEBI), the regulatory authority for capital markets, aims to bring about a substantial transformation in the manner in which mutual funds levy expenses on their customers. Through a recently released consultation paper, SEBI intends to streamline and enhance the definition of the total expense ratio (TER) by incorporating supplementary charges that fund houses were previously allowed to impose beyond the TER. Should SEBI’s proposal be implemented successfully, customers have the potential to witness a noteworthy reduction in the fees connected with investing in mutual funds. This move could contribute to making mutual fund investments more cost-effective and beneficial for customers.

Have a look at the five proposals

New Fund Offer inflows

SEBI found that 29 percent of New Fund Offer (NFO) inflows between April 2021 and September 2022 came from existing schemes of the same fund houses, with 93 percent coming from regular plans. Furthermore, nearly 72 percent of mutual fund investments were redeemed within two years. As a result, SEBI proposed that distributors will earn the lower commission if they switch your money from one scheme to another.

Investor education fund

SEBI aims to optimise the utilisation of the investor education fund, proposing that certain expenses previously charged to investors be covered by the fund. The B30 commission, paid to distributors for acquiring clients from beyond the top 30 towns, may also be sourced from the investor education fund. Sebi acknowledges that B30 investments are typically withdrawn after a year, but suggests continuing additional commissions to distributors for inflows from B30 towns.

Brokerage

Currently, equity funds have varying TER depending on the fund size, with additional charges allowed on top of the TER. SEBI’s internal study revealed that fund houses were charging higher brokerage amounts, sometimes exceeding the TER limit. Investors were unaware of these additional charges and ended up paying for research twice. The proposal seeks to address these issues and promote transparency in charges imposed by fund houses.

TER and changes

The market regulator proposes an overhaul of expense calculations for fund houses. Currently, expenses vary based on scheme size, benefiting large investors in debt funds but not retail investors in equity schemes. Additionally, different schemes within a fund house have varying expense ratios, leading to customer churning. SEBI suggests implementing category-wise expense ratios, where equity and debt schemes follow separate structures. The total assets determine the expense ratio, with higher assets resulting in lower expenses. All equity and debt schemes within a fund house must adhere to the assigned expense ratio, regardless of scheme age or size. This change aims to reduce expenses for larger fund houses.

Performance-linked fee

Investors question if fund managers should earn from underperforming mutual funds. Sebi found that only 40 percent of regular plans outperformed benchmarks in the past decade, and 27 percent in the last five years. Sebi proposes a performance-linked TER, charging management fees at redemption based on benchmark performance. Alternatively, the fund house may charge a TER and refund the management fee if returns fall short. Implementation challenges remain. Sebi suggests testing this approach in a sandboxed environment.