SEBI’s proposed changes to mutual fund regulations are oriented to enrich AMCs while small investors, who have lost money on several funds even after holding them for years, have been   brushed aside

The Securities and Exchange Board of India (SEBI) recently announced a slew of changes in order to increase the penetration of mutual fund products and to protect the investors’ interest. However most of these regulations seem geared to benefit asset management companies (AMCs) rather than investors. This is not surprising, since SEBI’s Mutual Fund Advisory Committee is packed with industry participants or dependents with only one member to represent investors.
 

The new rules that allow higher expense ratios to fund companies have failed to address the issue of performance. This means that fund houses that have failed to deliver returns over a period of time are still getting incentives to accumulate assets through their large distribution networks.

Depending upon the extent of new inflows from locations beyond top 15 cities the AMCs would be allowed to charge an additional TER (Total Expense Ratio) up to 30 basis points (bps). According to the SEBI circular, “AMCs will be able to charge 30 bps if the new inflows from these cities/towns are minimum 30% of the total inflows. In case of lesser inflows the proportionate amount will be allowed as additional TER.” The additional TER will be on the full fund corpus and not just only the fresh inflows.
 

Fund houses with the maximum presence in smaller towns and cities like that of LIC Nomura MF, UTI MF, SBI MF, HDFC MF, Reliance MF and ICICI MF would benefit the most. But getting inflows from smaller towns and cities is one thing; there is no mechanism to ensure that investors from these cities are protected against poor performance. Given the added incentive AMCs would be all out to push their products whether it would benefit the consumer or not. The small investor with lack of resources would stand to lose the most.
 

For the investors of HDFC MF, Reliance MF and ICICI MF, the performance of their equity schemes have been reasonable in the last five years; a 30 bps increase in TER would not have much of an impact on returns compared to the benchmark. But the same cannot be said about LIC Nomura MF. With the equity schemes of this fund house grossly underperforming the benchmark, an increase in TER would only make the fund house richer.
 

Take for examples the top schemes of HDFC or Reliance, they have returned around 9.90% compounded annually in the last five years while the Sensex has returned 2.93% in the same period ending 1st August 2012. One would not mind an additional TER of 0.30%. But what if the returns fail to beat even the benchmark, would it be fair to the investor to shell out extra for substandard performance?
 

SEBI’s attempt to curb churning is also confusing. The circular states, “the entire exit loads would be credited to the scheme while the AMCs will be able to charge an additional TER to extent of 20 bps. This will not result in any additional cost to the investors.” Therefore upfront commission that was being paid out from the exit load would stop as the entire amount would be added back to the fund. The AMCs would be compensated with a higher TER of up to 20 bps. But what if the amount generated through TER is greater than the amount generated through exit load, this would then be an additional cost to the investors.
 

SEBI also mentioned there would be a claw-back of additional TER (in the case of inflows from cities beyond the top 15 cities) would be provided to the extent the investments are redeemed within a period of one year. SEBI may have just succeeded in complicating the entire industry. They have just increased work for themselves. They would need to constantly monitor if the AMCs are adhering to the norms. And as we have seen in the past, SEBI has not been proactive to protect the investors. But who would stand to lose is the small investors.
 

In order to negate the hike in TER to increase distribution and to be fair to direct investors, SEBI mentioned there should be a separate plan for direct investments with a lower expense ratio. Though a lower expense ratio would benefit the investor in the long run, the main question is how many would actually choose the direct route seeing the cost benefits?
 

Three years back SEBI banned entry loads in order to attract investors and curb mis-selling, but how many investors put in their money? In fact all we have been seeing is net outflows since August 2009. Investors are not attracted to equities by themselves, they need hand holding. If this is implemented, AMCs would choose the online route which would be cost effective, if they had to set up their own offline distribution network for direct investments, they would have already done so. Therefore, how many would choose the online route? Going directly would be cheaper but how many investors are willing to do their own leg work?