No Entry Fee for Indian Mutual Funds – Really?

investingThe regulatory diktat of abolishing entry fee for mutual funds has received a good coverage in the financial media and blogosphere. Almost in all of the news coverage, it has been hailed as a beneficial to individual investors. Many financial and personal bloggers have also published individual post explaining how and why it will be good for individual investors. This was a typical example of herd mentality – everybody saying good so it is good. I am surprised that personal finance folks are also providing one sided opinion.

I found only one article by Shewta at Personal Money which provides a balanced analysis on the impact it may have on various players. I am taking this one step further to provide my understanding and implication on individual investors.

The entry fee of 2.25% was being charged by mutual funds (and asset management companies) under the pretext of expenses incurred in marketing and selling of the mutual funds. This amount was being paid to agents and distributions in the form of commissions. With abolishing of this fee, where will mutual funds get marketing and selling budgets? Does this mean they will stop marketing their funds?

One thing that is being overlooked in this euphoria is SEBI’s guideline that mutual funds can levy “a maximum of 1% of redemption proceeds”. In essence, what has happened is the diktat reworked the fees from upfront transaction and moved it at the back of the transaction. Now there are two aspects to this guideline:

  1. One would still see that the real advantage to individual investors is to the tune of 1.25%. But then, add the commission an individual will pay to the agents or distributor. In addition, the SEBI guideline also instructors agents/distributors to disclose commission they receive from funds (i.e. mutual funds can still pay commission to agents/distributors). Will this come from mutual funds own pocket? How can one stop mutual funds from increasing their operating expenses and charge it under some different heading? Time will tell how it evolves.
  2. The guideline says upto 1% of redemption proceeds can still be levied. Thus, if the redemption has significant profits and capital appreciation, the actual amount going back to the mutual fund is likely to be higher i.e. real return to individual will get reduced. Even at loss of capital, mutual funds can still charge up to 1% of the redemption value.

At least to me, the only silver lining in these guidelines is that individual investors will have higher capital value that is put to real work. The impact of upfront reduction in capital will be somewhat blunted. Also, the mutual funds performing good and providing better long term returns will actually get more money to keep. The actual value will be depend upon funds performance and invested time frame.

Mr. SEBI, Thank you for reworking the fee or commission structure.

To me, the concept of personal finance advising or agents should be purely a fee based structure. Personal finance advisor taking commission to sell products does not go hand in hand. It is contradictory.

Please note: I have not fully looked into the regulatory guideline or rule. My opinion is based on various news articles in media. I would be open to revisiting my viewpoint if anyone gives me any other evidence based data point.









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13 Responses to “No Entry Fee for Indian Mutual Funds – Really?”

  1. There are some important notes here

    AMC’s are allowed to use 1% of redemptions in mutual funds for commision to agents and all the marketing costs . its the money from exit loads which has to be utilized in commisions and other marketing costs . Most of the mutual funds have less than .5% of 1% of exit loads at this point and with this rule of SEBI , it can not go above 1% in future . also it can be “upto 1%” . So this 1% will be used for every types of costs incurred by mutual funds .

    Now most of the funds will have exit loads only if investors getout in short term like 6 months or 1 yrs. Hopefully it will not be after 1 yr . so its a concern for those who are short term investors . Its not a matter of concern for long term investors as far as i think .

    The second point about commisions to agents . it is a debatable topic and people have different views on this . my view is that with increased competition , there will less commision charged by agents . Also only good agents will survive the market now as people will only pay for quality advice . Agents who just gave top-5 mutual funds from some websites are going to be dead :) .

    Lets see how it unfolds in coming months. At this time we can only predict ;)

    However there are some learnings for me here .

    What do you think ?

    manish
    http://www.jagoinvestor.com

    • TIP Guy says:

      That’s very true that only time will tell. However, the fundamentals of this ruling or cost structure that is prevalent, is something that cannot be overlooked.

      I was not attempting to debating standalone 2.25% of entry load that is being abolished. Certainly, the removal of entry load of 2.25% will help bring down the preceived upfront commission down. There is surely an advantage.

      I am debating the overall impact of this ruling. I am looking for the full cycle (not the upfront entry fee removal alone). And from that perspective, I do not see a huge change, that is being made out of it. It is an improvement, but not the significant one.

      Regarding 1% exit load. The primary purpose of exit loads is to discourage investors to remove money from funds in short term. So far, majority of the funds had this only for 1 year of less. But now SEBI has knowlingly allowed the MFs to levy upto 1% exit load (irrespective of time frame). This is kind of giving free hand of MF to go ahead and do it. Time will tell.

      Almost every MFs already have 2%+ of operating expenses. Irrespective of fund performance, this operating expense gets deducted. So I do not think exit loads are not for operating expenses.

  2. Shweta Misra says:

    First of all Thanks TIP Guy for your appriciation of my article.

    I agree with Manish Chauhan, the exit load is capped at 1% now. But the applicability of exit load may now be reviewed by AMCs and investments greater than 1 year may also attract exit load now on as the entry load is zero for all.

    Further, the Fund Management Charge or FMC as mentioned by TIP Guy as operating expenses that get adjusted in the NAV of various MF Schemes stays and may also see an increase. thats why I say that it may not be a financial benefit for the retail investor as it appears in the first glance.

    However, this development will bring out quality in the services of MF Agents and Distributors. Thats definitely a plus!

    • TIP Guy says:

      Shweta,

      I would tend to agree with you views that (1) probability of financial benefit is none; and (2) one can expect quality of service/recommendation to increase.

      Thanks for your comment.

      Best Wishes,

  3. M Mansuri says:

    I have reading your blog and it an excellent one. It brings in a very fresh perspective to the world of investing. It is very good blog for do it yourself investors. I hope you are not one of those agents who is going to convert this to paid subscription. I have few comments.

    I see slow down in stock analysis. does that mean there is no stock that interest you for long term investing.

    I believe mutual funds are good investments because they generally provide good returns more than an individuals can have trading. they also provide benefits of diversification. why are you against mutual funds? I would like to read your views about what makes you hate mutual funds.

    • TIP Guy says:

      Mansuri,

      Thanks for your good words.
      Slow down in stock analysis is due to my schedule at work place. In my style of investing, I am always interested in stocks. Timming does not have significant role to play.

      I am receiving a lot of questions on my position about Mutual Funds. Give me sometime I will come with a post to provide a my perspective and my thoughts.

      Meanwhile, can you have give me some examples for MF that you would like to me to use as discussion point.

      Thanks for your comment.

      Best Wishes,

  4. I also agree on improvement of quality of service . Lets see what happens to levying of exit load for more than 1 yr on mutual funds .

    Manish

  5. R Bhatt says:

    Your blog is very good aand I like to come here to read it many times. I like the original fresh topic in your different posts. But many times i have different opinions. In my opinion is mutual funds are very good for investors who do not understand stock markets and do not have access to various investing knowledge and tools.

    As M Mansuri said, I would also like you to elaborate on why you think mutual funds are not a good investments.

    I am a financial analyst in financial services industry and believe only the quality will improve but overall fees will most likely remain unchanged most likely it will be worked out in different ways.

    good work.

  6. TIP Guy says:

    Bhatt,

    Thanks for your good words. As I mentioned above to Mansuri, give me some time, I will come up with my perspective of why I do not invest in mutual funds.

    Appreciate you leaving your comments.

    Best Wishes,

    • vojokotow says:

      Hello Mr.Tip Guy.Will you be please tell me when SEBI will implements this rule that investor may buy sell shares directly from bse,nse website and make payment online.Every time brokers are eating my % and if you calculate it is actually more than 2.25% entry load of equity mutual fund.Why need broker? I want to buy sell shares directly through stock exchange website.

  7. TIP Guy says:

    Vojokotow,

    I do not anticipate direct trading on BSE/NSE for retail or small investors. It can only be done through brokers (and/or sub-brokers). Even in developed world, such type of trading is not allowed.

    However, the difference is in India, the brokers eat away a lot of commission. In developed world, brokers have fixed low trading fee (and not % based). As Indian economy and financial services mature, it will come down.

    However, it may take few more years (may be 8 to 10 years before that happens).

    Best Wishes,

  8. Well, the broker’s fee is the most worrying factor for all the investors as they brokers are used to take a high trading fees.Investors can’t invest directly.

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