Capping The TER For The Benefit Of Investors
The market regulator, Securities and Exchange Board of India (SEBI) in its latest meeting has decided to cap the expenses ratio charged by the fund houses to investors. This change in slab rate of expense ratio is being done after a gap of almost 22 years and this change is for the first time after the slab rates were introduced in the year 1996. For beginners, the expense ratio is the cost charged by the asset management companies (AMCs) to an investor to manage their funds. This include fund management fees, agent commissions, registrar fees, selling and promoting expenses. All these come under the total expense ratio (TER), which are recurring in nature.
The TER is important from an investor's perspective as it is deducted from their investment and impacts the return they earn on their investment. Therefore, if everything remains the same, expense ratio becomes the deciding factor to select an MF scheme. This can be best understood with the following example. If you had investedRs.10 lakh in lump sum in a fund for 10 years that generated return of 15 percent and has an expense ratio of 2.5%, after 10 years you would getRs.3.24 lakh. All things remaining the same, if we reduce only the expense ratio by 1% to 1.5% you would getRs.3.54 lakh during the same period, which is around 10% higher than the final amount and 35% higher than the initial investment.
The Recent Change
Despite the mutual fund industry growing by leaps and bound since the expense ratio slabs were introduced for the first time, the investors did not derive any benefit and any economy of scale achieved by the AMC was not passed on to the investors. The industry’s AUM grew fromRs.80,000 crore at the end of July 1999 toRs.25.2 lakh crore currently. Hence, SEBI, acting in the interest of the investors, modified the slab-wise limits for expense ratio of open-ended funds for equity oriented funds as well as “other” funds. The TER stands reduced by 25 basis points in the top slab for both equity and debt mutual funds. Further, the regulator has asked fund houses to adopt the full trail model of commission in all schemes without payment of any upfront commission or upfronting of any trail commission, the only exception being the systematic investment plan (SIP). 
SEBI’s new norms impose caps on the expense ratios based on the AUMs of these funds. Smaller funds have the highest permissible expense ratio, which may put larger schemes at a disadvantage. This might also compel distributors to push for schemes with AUMs uptoRs.500 crore as permissible expense ratios are higher and commissions that distributors get are also likely to be higher.
Among the equity funds, the closed-ended schemes that account for liSEBI’s new norms imposettle less than 6% of total AUM under equity and balanced funds are going to hurt the most. The TER for closed-ended and interval schemes for equity-oriented schemes has been capped at 1.25 percent, and for other than equity oriented schemes, TER will be a maximum of 1 percent. This may impact the new launches of closed-ended schemes and only schemes that have investment merit will be launched.
Conclusion
The recent action by SEBI will impact different stakeholders of the mutual fund industry in different ways. In the short run, it will have a negative impact on the financials of the AMCs; however, in the longer run, these AMCs are also going to be positively impacted by higher volumes as anything that is good for the investors is good for the AMCs and the industry in general.
However, investors will be the greatest beneficiaries of the change. Besides the recent change in expense ratio slab, the earlier reduction in additional TER that could be charged in lieu of exit loads (from 20 bps to 5 bps) and the change in the additional TER chargeable for pay-outs for inflows from B-15 cities to B-30 cities should result in a meaningful reduction in overall TERs. All of these is likely to increase the returns an investor gets in his hand.