Looking to pass on the benefits of economies of scale to the mutual fund investor, the Securities and Exchange Board of India (Sebi) last week announced a rationalisation in the total expense ratio (TER) charged by mutual funds from investors. While mutual funds have been allowed to charge a higher expense ratio (maximum of 2.25%) for schemes with assets under management (AUM) of up to Rs 500 crore, they will have to reduce the TER in line with the growth in AUM of the scheme.
Benefits of economies of scale
If, four years ago, an MF scheme had AUM of, say, Rs 1,000 crore, which has now grown to Rs 5,000 crore as a result of fresh inflows and rise in market value of investments, at the same TER the revenue would have risen significantly. At a TER of 2.25%, while the MF was getting revenues of Rs 22.5 crore on an AUM of Rs 1,000 crore in a year, on an AUM of Rs 5,000 crore, it would get Rs 100 crore even if it charged only 2% TER.
It has been argued that while the MF industry has benefited in terms of growth in revenues from the rise in AUM, the benefits had not been passed on adequately to investors, even as their expenditure on managing the fund rose marginally. “While the AUM has grown multiple times, the benefit of economies of scale has not been fully shared with the investors. The Board took note of the benefits of the proposal with respect to sharing of economies of scale, lowering the cost for mutual fund investors, bringing in transparency in appropriation of expenses, and reducing mis-selling and churning,” Sebi said in its note announcing the TER rationalisation.
Data from the Association of Mutual Funds of India show that the AUM of the MF industry jumped from Rs 9.45 lakh crore in May 2014 to Rs 25.2 lakh crore in August 2018. The equity AUM grew from Rs 166,826 crore to Rs 712,665 crore in the same period.
TER and the change
Total expense ratio is a measure of the total cost an investor incurs while investing in a mutual fund. It includes fees and expenses including investment and advisory fee, marketing expenses, brokerage, audit fee, custodian fee, and expenses of trustees, among others. It is calculated by dividing the total annual cost by the fund’s average assets over that year, and is expressed as a percentage.
Until last Tuesday, MFs were allowed to charge TER of up to 2.5% for fund of fund schemes and 1.5% for index funds or exchange traded funds. For all other schemes, they could charge 2.5% on the first Rs 100 crore of AAUM (average AUM), up to 2.25% on the next Rs 300 crore, and up to 2% on the following Rs 300 crore of AAUM. On the balance of the assets, they could charge up to 1.75%.
In addition to these limits, fund houses were also permitted to charge up to 0.3%, if 30% of the gross new inflows in the scheme, or 15% of average AUM (AAUM) of the scheme, are from cities other than the top 15.
Since the announcement of the new structure Tuesday, for all open-ended equity schemes, the TER for schemes with AAUM up to Rs 500 crore has been fixed at 2.25%. For schemes with a higher AAUM, the TER goes down to 1.5% for schemes with AAUM Rs 5,000 to Rs 10,000 crore. For schemes between Rs 10,000 crore and Rs 50,000 crore, the TER goes down at a rate of 0.05% for every Rs 5,000 increase in AUM. For schemes with AAUM over Rs 50,000 crore, the TER will be 1.05%.
How investor will benefit
Investors can save up to 80-90 basis points in charges, every year, on their AUM. For example, the SBI Bluechip Fund (AUM over Rs 20,000 crore) has a TER of 2.35%. Under the new rules, the TER will come down to 1.4% (plus the additional TER on account of inflows from B-15 cities), and thus the investor will save between 80 and 90 basis points. An investment of Rs 1 lakh in the scheme, growing at, say, 10% for 20 years with a TER of 2.35%, would have grown to a corpus of Rs 4.18 lakh; the same investment with a TER of 1.5% would grow into a corpus of Rs 4.99 lakh.
For regular growth schemes such as Aditya Birla Sunlife Frontline Equity (AUM Rs 21,880 crore) the TER comes down from 2.18% to 1.4% (plus additional charge on inflow from B-15 cities) within the scheme. With the changes brought in, the regular schemes will now come much closer to the direct plans offered by them in terms of TER. The direct plan of Aditya Birla Sunlife Frontline Equity has a TER of 1.31%.