Securities and Exchange Board of India (Sebi) has stepped up in favour of investors once again, ordering mutual fund houses to cap their scheme expenses and provide the benefit of 'economies of scale' to investors as well as clamp down on mis-selling and churning.

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Following a board meeting yesterday, Sebi chairman Ajay Tyagi announced that the Total Expense Ratio (TER) of open-ended schemes be capped according to the AUM slabs.

TER is the total cost an investor has to pay while investing in mutual funds. Since TER is an annual charge, it eats into an investors returns through the compounding of the principal amount.

This move by Sebi is the first major revision to the TER slab since its introduction in 1996. The rationale is simple - while the industry has grown manifold, the benefits of scale have not been shared with investors.

Additionally, in a bid to standardise the expenses and commissions, Sebi has asked the mutual fund industry to adopt the full trail model of commission on all schemes without payment of any upfront commission or upfronting of any trail commission.

The trail commission means that it's paid every year only for as long as an investor remains with that scheme.

At the moment, most fund houses pay an upfront commission as high as two percent and this is a practice which many say leads to mis-selling (as sectoral funds etc. may incentivise advisers with larger commissions).

The trail model, now proposed by Sebi (except for Systematic Investment Plan) would benefit a distributors if their clients stay invested in schemes for a longer period, thereby doing away with the rampant practice of mis-selling and portfolio churn.

The market regulator has also added that all commission and expenses be paid from the scheme and not the asset management company (AMC) or associate or sponsor or Trustee or any other route. This would further provide objectivity when schemes are recommended.

Companies would ideally pass on the majority of this TER cut to distributors like they did in June, when the fees were cut by 15 bps.

One basis point is a hundredth of a percentage point.

But, given the quantum of the cut, it's likely that AMCs will have to absorb some of the impact.

Equity funds form 40 percent of total funds and drive 70 percent of the industry revenue and this is the bucket that will take the biggest knock.

Larger AMCs may see a higher impact given a higher share of equity AUMs and larger funds. The impact on debt funds is seen to be minimal.

JPMorgan says the biggest impact could be felt by the large AMCs given the high concentration of assets by the top 5 mutual funds.

One of the immediate fallouts, therefore could be distributors would start pushing schemes from smaller AMCs, where the scope for earning commissions would be higher.

A Balasubramanian, chief executive officer, Aditya Birla Sun Life AMC, agrees that the market share might move from large to smaller players.

Aashish Somaiyaa, chief executive officer, Motilal MF welcomes the move as he sees a fall in investment churn, but he cautions that gross inflow would decline.

With this cut in mutual fund expenses, the gap between the regular and direct schemes is also expected to narrow, something that Sebi has been batting for a while now.

While investors are set to benefit, the fragile distribution network of the mutual fund industry could well suffer a body blow.

Industry insiders explain that households running on mutual fund industry income (minimum Rs 5 lakh a year) is a meagre Rs 10,000 odd.

The expansion of this group could now hit a roadblock and severely impact penetration. Besides the metro cities, most investors rely heavily on distributors and advisors and a new kind of mis-selling could now emerge depending on where the maximum leverage can be found.

In the larger context though, while AMCs will lose some operating efficiencies and perhaps even a loss of earnings, but investor perception will help them tide over the blues over the longer term.

* Please consult an adviser before making changes to your portfolio

First Published:Sept 19, 2018 5:32 PM IST