Capital markets regulator Securities Exchange Board of India (SEBI) is currently mulling over a proposal to determine the total expense ratio (TER) based on the total equity and debt assets held by a mutual fund house, instead of tying it to individual schemes.
Experts and mutual fund industry insiders suggest that the new rule, when passed, would bring the TER down.
Before we proceed further, let us understand what exactly is TER?
What is a TER?
It refers to the operating expenses charged by an asset management company (AMC) from investors for managing the scheme.
These expenses include sales and marketing, advertising, administration expenses, transaction costs, investment management fees, registrar fees and audit fee, among others.
SEBI has already set maximum limits of TER which is based on the assets under management (AUM) of a fund scheme.
What is the existing rule?
As of now, fund houses are free to charge a TER on the basis of a fund scheme’s size. Higher the AUM, lower the TER and conversely — lower the AUM, higher the expense ratio the AMC can charge.
So, effectively what happens is that even a large fund house can charge a higher TER from the investors in a new scheme while it is already is running a number of schemes in the same category with a large AUM.
What is the proposal?
The proposal under consideration suggests that the TER will be determined by the scheme’s category. This means all the schemes that fall under one category — equity or debt — will have the same TER.
S Sridharan, Founder and principal officer of Wealth Ladder Direct, says that it would be a welcome rule to limit the expense ratio and would stand to benefit the mutual fund investors at large.
“The overall cost of investing would fall for investors when this change goes through. Importantly, this would be a fairer system to follow. It’s unreasonable to charge, for instance, a higher expense ratio on a large cap scheme that is smaller in size while the same fund house is running another large scheme in the same category,” he says.
Ravi Saraogi, CFA, Founder of Samasthiti Advisors, however, plays this down by stating that the expense ratio is already quite low and doesn’t make any dent in the investors’ pockets.
“In case of mutual funds, the general sense is that the expense ratio is already very low as compared with what they have, say, in insurance. This is a micro-regulation which wouldn’t have much impact on investors because there is already a cap on the TER. Moreover, investors are free to opt for whichever scheme they want to choose. So, the market forces can determine such things,” says Saraogi.
In conclusion, we can say that the markets regulator is set to cut down on higher expenses charged by AMCs. And when the new rule comes into force, investors will, by and large, pay a lower cost for investing in mutual funds which appears to be a good move, at least on the face of it.