Mutual Funds

Opinion | Why SEBI should stop worrying about high MF expense ratios

The Securities and Exchange Board of India (SEBI) wants to review whether Indian mutual funds are overcharging their customers by imposing a high total expense ratio (TER).

TER is the cost that an asset management company (AMC) charges for managing an investor’s money and includes various fees and expenses. But should the regulator interfere or should it let market forces decide the TER?

A report by Morningstar, a mutual fund advisory, said that India was among the most expensive markets when it comes to expense ratios. This was strongly contradicted by the Foundation of Independent Financial Advisors, an industry association of financial advisers, which benefits from higher fees.

To be sure, there is no argument why mutual funds should charge a fee. Asset managers have costs associated both with managing money as well as collecting it from investors. There are also promotion and marketing costs.

Now, mutual funds, insurance or for that matter any financial products are typically ‘push’ products. The financial literacy in the country and the level of time an investor can devote to managing her money has necessitated the creation of an entire industry called financial advisors. This industry is driven largely by commissions.

The point that is debatable is how high can these fees and commissions go and whether the consumer gets benefits for what she pays.

Retail investors typically end up being charged the most. High net-worth individuals (HNI) are treated better, but not always.

The recent settlement between actress Suchitra Krishnamoorthi and her bank HSBC highlights how bigger institutions and brokers treat customers money. In this case, Krishnamoorthi was assured of a 24 percent return if she appointed the bank as her portfolio manager. The bank, in turn, invested her money in 38 different funds and was found to be ‘excessively churning’ her money. As banks and portfolio managers earn their revenue from the fees the AMCs pay them, they are encouraged to churn the portfolio into various schemes. The salary of the relationship manager or financial advisor is linked to the revenue he generates through such fees.

Then, there is the blatant abuse of commission. HDFC Chairman Deepak Parekh said that he was personally against the practice of rewarding distributors with foreign trips in the garb of training programmes which is a common practice now.  While such practices may impact the smaller to medium-sized distributors, the bigger ones go scot free.

Moreover, the size of the mutual fund industry has also increased exponentially. Large fund houses are making 40-50 percent profit margins, pointed out SEBI chief Ajay Tyagi. There is a case for costs to come down as a portion of assets under management. At the same time, many actively managed funds are seeing their alphas (extra returns over the benchmark) getting smaller.

Having said that, the fact remains that when it comes to health or wealth, a customer prefers to let professionals handle it. A recent survey conducted by Paisabazaar.com found that 96% of its non-mutual fund consumers were not aware of the existence of direct plans of mutual funds even though it was launched in 2003. This is despite the fact that the TER in a direct fund is much lower and returns higher.

The portfolio management scheme (PMS) industry is also a case in point, where high fees haven’t deterred growth. Wealth managers, who get a flat fee for managing their clients’ assets, also get a commission from the PMS manager. The point here is that if there is a superior product in the market, then customers are willing to pay higher fees.

In the ultimate analysis, it is worth remembering that the financial sector in India is just developing. Despite growing nearly four-fold in the past five years, assets under management in the country are just 11 percent of GDP compared to the world average of 62 percent. Like any other industry, the financial services industry is maturing and the commissions will shrink as competition increases. There is nothing stopping an investor in moving away from a distributor or an advisor to a direct investment plan.  The fact that they want to rely on experts to do so is a message to the regulator to stop bothering about commissions.

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