Certain fund houses are charging investors an additional 20 basis points, which the regulator gave as an incentive for crediting exit loads back to the scheme, even though the schemes are close-ended

Over the past one year, as many as 40 close-ended equity schemes have been launched. However, for the investor, such schemes not only turn out to be illiquid but expensive too, thanks to our regulator and greedy fund houses.

In August 2012, the Securities and Exchange Board of India (SEBI) issued a press release on mutual fund regulations which mentions that “the entire exit loads would be credited to the scheme while the AMCs will be able to charge an additional expense ratio to the extent of 20 bps”. It seems that close-ended schemes that do not allow investors to exit, are taking undue advantage of the ‘incentive’ given by the regulator, by charging the additional expense ratio.

As per SEBI regulations, fund houses can charge an expense ratio of up to 2.50% for investment management and advisory fees. Additional expense of up to 30 bps can be charged based on the inflows from beyond the top 15 cities. Additional expense of 20 bps is allowed for recurring expenses, an incentive given by the regulator to fund houses as exit loads are credited back to the scheme. Therefore, adding the above expenses, a fund house can charge an expense ratio of up to 3%.

On an average, a single close-ended scheme is able to gather assets of just about Rs100 crore-Rs200 crore. The expense ratio of these schemes is anywhere between 2.80%-3% annualised. The average expense ratio of the 200-odd equity diversified schemes in existence works out to 2.40%. Of the 22 close-ended equity schemes that have disclosed their expense ratio, six schemes have charging an expense ratio of 2.80% and above.

Fund houses prefer to launch close-ended schemes as the assets are locked-in for the tenure of the scheme. It can be seen that most fund houses are charging the full expense ratio for close-ended schemes, where ideally, the total expense ratio should be a maximum of 2.80%. As SEBI has not specifically mentioned the relation of the additional expense ratio to the exit loads charged in the regulation, fund houses are taking undue advantage because they can charge an additional 20 bps irrespective of whether or not exit loads are charged.

At the losing end is the investor who ends up paying an additional cost. Unfortunately for them, they can’t even exit the scheme and would end up paying the high expense ratio.

In the press release at the time of forming the regulation, SEBI mentioned that “This will not result in any additional cost to the investors.” Unfortunately, the regulator failed to do a thorough research. Will the regulator act now seeing that fund houses are taking undue advantage?

Source: ICRA Online