The benefits of investing in mutual funds are well-known and widely touted. A major attraction held out is that investors in mutual fund get the benefit of an expert investment manager and professional management and housekeeping of records. But fund managers are also often among the highest paid corporate managers, and the establishments of fund houses are also not cheap. So, who pays for all this? Well, since there is no such thing as a free lunch, it shouldn't come as a surprise that it's the fund investors who foot these bills. Find out how much this can set you back by...
Expenses incurred by mutual funds are a critical factor because they eat into the returns which would otherwise be available to investors. Internationally, therefore, expense ratio is an important parameter when funds are compared. In India, however, this has not always been the case and it's only during the last few years that investors have begun to appreciate the significance of expense ratios.
Management fees
The investment and advisory fees that the AMC proposes to charge the mutual fund has to be disclosed in the offer document.
The regulations prescribe the following limits on the management fee that can be charged by the AMC each year:
To clarify:
In the case of fund of funds schemes, the total expenses including the management fees shall not exceed 0.75% of its daily or weekly average net assets, depending upon whether the NAV of the scheme is calculated on daily or weekly basis.
If the AMC decides not to recover load from investors, it can recover an additional 1 per cent as management fee. Thus the limits would be:
The recovery of the incremental management fee is permitted only until the initial issue expenses (subject to limit of 6 per cent on resources mobilized) have been recovered.
The regulations also prescribe that the following items will be kept out of net assets for the purposes of calculating management fees:
In addition to the initial issue expenses and management fees, the following recurring expenses can be charged to the fund:
Expenses other than the above, which are directly attributable to the scheme, may be charged to the scheme with the approval of the trustees and within the overall limits. However, the following cannot be charged to the scheme:
The regulations prescribe the following limit on recurring expenses (excluding the initial issue expenses and redemption expenses, but including management fees):
|
Weekly Average Net Assets |
Equity Schemes |
Debt Schemes |
|
First Rs. 100 crore |
2.50% |
2.25% |
|
Next Rs. 300 crore |
2.25% |
2.00% |
|
Next Rs. 300 crore |
2.00% |
1.75% |
|
Excess over Rs. 700 crore |
1.75% |
1.50% |
For balanced schemes, the limit would depend on whether the scheme is predominantly invested in equity or debt. Accordingly, either the equity scheme limit or the debt scheme limit would apply. Expenses above these limits cannot be charged to the investors.
As seen above, one per cent higher management fee is permissible in the case of "no load" schemes. But the management fee would need to be accommodated within the overall expense limits.
Loads
Types of loads
Deferred Load
Deferred loads are not applicable on open end schemes.
An AMC may decide that investors should pay more than NAV for their investment in each unit of the scheme. This incremental amount paid by new investors is called "entry load", or "front end load". Thus, if a scheme has NAV of Rs. 11 and entry load of 5%, the investor would pay Rs. 11.55 for each unit:
Sale Price = NAV plus Entry Load
The entry load (Re. 0.55 in the above case) would be retained in a separate account from which the AMC would meet part of its selling and distribution expenses. Generally, debt schemes do not charge an entry load.
An AMC may decide that sellers would recover less than NAV for the units they sell in a scheme. This shortfall, borne by existing investors, is called the "exit load" or "back end load". Thus, if a scheme has NAV of Rs. 11 and exit load of 5 per cent, the investor would receive only Rs. 10.45 for each unit redeemed.
The exit load (Re. 0.55 in this case) would go into a separate account from which the AMC would meet part of its selling and distribution expenses:
Re-purchase Price = NAV minus Exit Load
Contingent deferred sales charge (CDSC)
AMCs often choose to reward investors who stay with them longer. This is achieved through a Contingent Deferred Sales Charge, where the longer an investor holds on to her units, the lower the CDSC she bears.
For instance, there could be a load of 2 per cent if the investor exits within 1 year; the load could go down to 1 per cent if the investor exits after 1 year but within 2 years; and no load if the investor stays on for 2 years.
Loads reduce the returns to the investors. Hence the need for restrictions on the load that AMCs can charge.
The regulations provide that:
for a scheme of NAV Rs. 20, if the AMC would like to sell new units at Rs. 21.40, the re-purchase price cannot be lower than Rs. 19.902 (Rs. 21.40 multiplied by 93%); and
for the same scheme, if the AMC would like to re-purchase existing units at Rs. 18.60, it would need to bring the sale price for new units to a maximum of Rs. 20 (Rs. 18.60 divided by 93%).
|
Redemption in the first year |
4% |
|
Redemption in the second year |
3% |
|
Redemption in the third year |
2% |
|
Redemption in the fourth year |
1% |
Excerpt from: Indian Mutual Funds Handbook
Author: Sundar Sankaran
Price: Rs 395/-
Sundar Sankaran, an authority on the subject of mutual funds, has handled more than 200 seminars on the subject all over India.
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