The capital market regulator, the Securities and Exchange Board of India (Sebi), has once more moved in investor interest in the mutual fund industry. The mutual fund you buy will soon cost less, be less prone to mis-selling and be more transparent. These are the four changes that will make an already investor friendly product go several steps ahead.
One, Sebi has lowered the costs in a mutual fund. An expense ratio in a mutual fund is the cost that the investor pays. The regulator fixes the maximum a fund can charge and leaves it to competition to drive costs down. Levied on the assets under management (AUM), these costs were fixed in 1996 when the industry size was around ₹30,000 crore. Costs in a mutual fund were expected to come down as the size grew because fixed costs do not grow with the size of the AUM. The benefits of larger size, it was assumed, would be passed on to the investor. The industry size is now ₹25 trillion but the costs in the retail part of the market have stayed near the maximum limits; in the institutional part (liquid funds and debt funds), costs have been slashed due to the higher bargaining power of the big customers. Retail customers have no organised voice and continued paying more even as the size of the industry indicated a cost cut. Sebi has now cut the maximum a fund can charge and costs over the board will come down.
ICICI Prudential Mutual Fund’s new fund offer (NFO) of Bharat 22 exchange traded fund (ETF) is in the market this week seeking investor money for the government’s disinvestment programme. Looking through the document, I was struck with the expense ratio of this fund. At 0.0095% per year, this is the cheapest ETF in the market today. Understand what this cost means first. The expense ratio describes the price you pay for the facility of handing your money over to a fund manager and it is charged on your funds under management. For example, a Rs10 lakh corpus, with an expense ratio of 1%, will cost you Rs10,000 a year. You don’t have to cut a cheque for this cost since it is taken by the fund house out of your corpus—that’s why it is called net asset value, it is ‘net’ of costs. Expense ratios have a big impact on investor returns over a lifetime of investing. At 0.0095%, Bharat 22 will cost you Rs95 a year. Reliance AMC’s CPSE ETF (the first government disinvestment fund) costs 0.07% or Rs700 a year. A 2% managed fund expense ratio costs you Rs20,000 a year.
Are loads back? The distribution industry was agog when news filtered out last week that the Bajpai committee set up by the Pension Fund Regulatory and Development Authority (PFRDA) had recommended a 50 basis points (bps) charge on the National Pension System (NPS) point of sale. A quick backgrounder: The Bajpai committee was set up to find out why the low-cost NPS is not popular with the retirement corpus-targeting Indian. Less than 50,000 people have handed over about Rs 100 crore of funds to NPS in the two years it has been thrown open to the Indian public. In contrast, equity funds have gathered a net of Rs 470 crore of retail money in the past 12 months despite the absence of a load on the product.
For equally good food, which cafe would you pick—one that has good parking and is on the ground floor or another that has difficult parking and is two flights up a dark stairway? I find myself choosing the first over the other most times. I also find my selection process sensitive to costs of access such as parking fees. I tend to avoid places that will charge more than the usual Rs10 as parking.
One of the reasons the new pension system (NPS) had got good previews before launch was due to the tiny costs the scheme carried. However, newspaper edits this week suggest that there is fine print to be looked at and that the product is not as cheap as touted.
The criticism also is that the product is elitist and does not work for a poor person who will invest the minimum Rs6,000 a year but will pay the same upfront cost as a person investing Rs1 lakh. Is there truth in this cost argument?
Any discussion on cost cannot be restricted to only one facet of the cost. A financial product carries at least three kinds of costs: You have to pay to get on the bus, that’s the entry load. You have to pay to ride the bus, that’s the annual recurring fund management and other annual administrative costs. And last, you pay to get off the bus, that’s the exit load.