The Securities and Exchange Board of India has finally stepped in with a long-pending twin move to clear the air on amortisation of NFO (new fund offer) expenses and set norms on dividend declaration.
In our view, both these moves deserve the thumbs up from the investing community. They will get the thumbs down from the distributor community, but as far as we are concerned mutual funds are meant to serve the investor's interests.
Over the months, Personalfn has time and again made its stand clear on initial issue expenses. We have strongly advocated that the practice of amortising the NFO initial issue expenses over five years be done away with since a lot of investors aren't even invested till the end of the first year, let alone the fifth year.
That is why it is only fitting that AMCs (Asset Management Companies) write off the expenses in the first year itself. There was a crying need to eliminate the disparity between the expenses charged to various groups of investors and put short-term NFO investors at par with long-term NFO investors.
Expectedly, Sebi has stepped in to set some standards that mutual funds will have to necessarily comply with. Gone is the discretion for fund houses to amortise initial issue expenses over five years. In fact, initial issue expenses, as we know them are now a thing of the past.
Now all open-ended NFOs will have to necessarily charge the entire initial issue expense through the entry load. So if an open-ended NFO has an initial issue expense of 6.00% (i.e. maximum an NFO can incur), this will have to reflect by way of an entry load. In such a scenario, the NAV (net asset value) on the very first day will be as low as Rs 9.40 (6% on a Rs 10 unit). So the 'fly by night' NFO investor is on a level field vis-à-vis the serious, long-term NFO investor.
http://www.personalfn.com/research-it/mutual-funds/mfunds.pdf Click here to read the SEBI circular on NFO expenses and dividend declaration
Of course, fund houses have the option to absorb a part of this entry load. So if the initial issue expense is 4.00%, the fund house has the option of charging only 2.25% to the fund and absorb the balance 1.75% in its books.
However, we don't expect this kind of benevolence from too many AMCs. It is more likely that distributor commissions will be squeezed and a lot of 'wasteful expenditure' will become a thing of the past.
Initial issue expense norms for close-ended NFOs are a little different.
They can amortise initial issue expenses over five years, however, they cannot charge an entry load. If they do charge an entry load, then they cannot amortise expenses, as the entry load represents the initial issue expense.
Another norm established by SEBI is with regard to dividend declaration. This was another reform screaming to be implemented. And those who attended the Mutual Fund of The Year Awards instituted by CNBC-TV18 and BNP Paribas in Mumbai probably saw this one coming from some of Damodaran's remarks with regards to dividends.
Until now mutual funds had a field day making grand dividend announcements with the objective of roping in fresh investors to boost their net assets under management. These announcements were usually made well in advance (at times more than a month in advance) to give the sales team enough time to contact clients to cash in on the dividend opportunity.
With dividend declarations exceeding 100% (on a unit) at times, you had a lot of investors rushing in to write cheques to the mutual fund without even checking on fundamentals like the nature of the fund (diversified equity, sectoral/thematic) or if the fund was a fit in their portfolios.
Not surprisingly, given how blatantly this was being practiced by fund houses, it was only a matter of time before Sebi would take steps to curb this malpractice. As per Sebi's norms, mutual funds will now have to declare dividends a day after getting the go-ahead from the Trustees.
They will have to communicate the same to investors the very next day through a notice in a particular format. The record date for the dividend will be five days after the date of notice. The fund house will have to clearly mention that the NAV will fall to the extent of the dividend.
This was necessary since a lot of investors were led into believing that the dividend is something they get over and above the NAV, not realising that it eventually comes out of the NAV.
In our view, these are all very positive steps taken by Sebi. It is unfortunate that AMCs allowed matters to come to a head that made the regulator step in to clean the mess. It would have been far better if fund houses had shown some self-restraint and had taken a stand to place the investor's interests before their own.
The hints dropped by Sebi expressing its anguish over the state of affairs did not seem to have the desired effect. Ultimately, Sebi did what it had to do and in the final analysis it could well be the investor who will be laughing all the way to the bank.
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