SEBI targets cost efficiency for mutual funds

Welcome to this week’s edition of our newsletter! In recent regulatory developments, the Securities and Exchange Board of India (SEBI) has taken a proactive approach to strengthening the regulatory framework for mutual funds. A significant milestone in this journey is the release of a comprehensive 40-page consultation paper by SEBI, which outlines proposed revisions to the total expense ratio (TER) imposed on mutual fund investors. This paper is a testament to SEBI’s commitment to fostering a transparent and investor-friendly environment.

Currently, the consultation paper is in the crucial stage of seeking industry feedback, as SEBI eagerly awaits valuable insights and perspectives from market participants. Within its 40 pages, the paper covers 15 key topics open for discussion and deliberation. These topics touch upon various aspects of the mutual fund ecosystem, including expense ratios, investor protection measures, disclosure requirements, and more.

Here are a few notable takeaways for investors to consider if the recommendations are implemented:

1. Enhancing Transparency and Investor Protection

As an everyday investor, it’s essential to understand the current regulations governing Mutual Funds and their associated expenses. Mutual Funds can charge four additional expenses on top of the specified Total Expense Ratio (TER) limits. These additional expenses were introduced to address various concerns, such as making Mutual Funds more accessible, managing institutional investor concentration, and promoting industry growth.

However, in recent years, the Mutual Fund Industry has seen significant growth, with more and more retail investors like yourself participating. This changing landscape has raised questions about the continued relevance of these additional expenses.

To promote transparency and protect investors like you, the Securities and Exchange Board of India (SEBI) has proposed a rule regarding the Total Expense Ratio (TER). The TER represents the maximum amount you may be charged as an investor. It should include all the expenses that Mutual Funds are permitted to charge, and you should not be charged anything beyond the prescribed TER limits.

Let’s break it down with an example. Suppose you have invested Rs. 10,000 in a Mutual Fund with a base expense ratio of 1.5%. However, considering all the actual expenses, the net effective ratio would be around 1.71%. SEBI’s proposal aims to ensure that the effective expense ratio reflects all the expenses incurred by the investor. Asset Management Companies (AMCs) could not add any extra expenses.

SEBI aims to increase transparency and protect investors’ interests in the Mutual Fund industry.

2. Reforming Total Expense Ratio (TER) Structure:

The current rules for Total Expense Ratio (TER) in Mutual Fund (MF) Regulations aim to share the advantages of cost savings achieved by Asset Management Companies (AMCs) with investors. However, the TER slabs are currently determined by the schemes’ total assets under management (AUM), which may not accurately represent the cost savings at the specific asset class level. It is essential to enable the growth of AMCs of all sizes while ensuring fairness and avoiding unfair advantages between different investment schemes.

Impact:

Investor Takeaway: If the proposed slabs for Total Expense Ratio (TER) are implemented, it is expected to result in reduced expenses for investors of equity, hybrid, and solution-oriented schemes. As an investor in these types of Mutual Funds, you may enjoy lower costs associated with your investments.

3. Proposal to introduce performance-based TER – Win-Win for investor & fund manager:

Mutual fund companies may introduce performance-based fees. This means they can charge an extra fee if the fund performs well and meets a specific minimum return called the hurdle rate. However, if a mutual fund underperforms and fails to reach the minimum return, it cannot charge additional fees beyond the base rates. This mechanism ensures that you, as an investor, are only charged extra fees when the fund achieves positive results, incentivising the fund managers to strive for better performance.

Impact:

This change will benefit investors by eliminating the need to pay additional fees over the base fees when a mutual fund underperforms. It provides a safeguard against extra costs during times of poor fund performance. Moreover, this change also incentivises fund managers to maximise their investments, as they can earn additional revenue when the fund performs better than expected. Ultimately, this adjustment aligns the interests of investors and fund managers, fostering a focus on achieving favourable investment outcomes.

4. Proposal to cap exit load:

Currently, mutual fund companies can charge a fee of five basis points (bps) to a scheme, even if no clawback or exit load is credited. However, the Securities and Exchange Board of India (SEBI) has noticed that the total additional expenses charged to the scheme are more than those recovered from investors through exit loads.

To address this issue, SEBI proposes discontinuing the provision that allows charging an additional expense of 5 bps for schemes with an exit load provision. Additionally, SEBI suggests reducing the maximum permissible exit load from 5% to 2%.

Impact:

These proposed changes aim to protect investors and ensure fair practices in the mutual fund industry. By eliminating excessive charges and reducing the maximum exit load, investors can have a more transparent and investor-friendly experience.

We have selected the most significant announcements from the consultation paper. To access the complete consultation paper, click here.

 Investor Takeaways:

The recent regulatory developments by SEBI aim to strengthen the mutual fund industry and protect investors’ interests. Proposed revisions to the total expense ratio (TER) and the introduction of performance-based fees are expected to enhance transparency and reduce investor expenses in specific schemes. These changes align the interests of investors and fund managers while promoting fair practices. Additionally, SEBI’s proposal to cap the exit load at a maximum of 2% aims to protect investors and ensure a more transparent and investor-friendly experience. Stay informed to make informed investment decisions.

Markets this week

Source: BSE and NSE

• Markets witnessed ended on a negative note.
• Volatility dominated the Indian market in the week ending May 19, resulting in a 0.7 percent decline. This was influenced by mixed global cues and mounting concerns surrounding the US debt ceiling.
• Despite the overall downward trend, the market received support from improved earnings and investments from foreign institutions, which helped limit the extent of the decline.
• The domestic market’s upward momentum, fueled by Foreign Institutional Investors (FIIs) and domestic investor inflows, faced challenges due to weak cues from global markets during this week.
• The moderation in domestic inflation validated the central bank’s decision to maintain a pause on interest rate hikes, indicating a cautious approach to monetary policy.
• India’s industrial production growth decelerated from 5.6 percent in February to 1.1 percent in March, primarily driven by weaker performance in the power and manufacturing sectors. This slowdown in industrial production contributed to the market’s overall performance during the week.
• Foreign institutional investors (FIIs) displayed a positive sentiment in the Indian equity market, purchasing equities worth Rs 4,098.2 crore during the past week.
• On the other hand, domestic institutional investors (DIIs) opted to sell equities worth Rs 677.45 crore in the same period, indicating a more cautious approach from local investors.

Weekly Leaderboard:

Source: BSE

Stocks that made the news this week:

👉SBI exceeded analysts’ expectations by reporting an impressive 83% surge in net profit for the fourth quarter. This growth was driven by higher core income and reduced provisions. Additionally, SBI showcased effective management of non-performing assets (NPAs), with the net NPA declining to Rs 21,466 crore in the March quarter from Rs 27,965 crore previously

👉ITC Ltd. reported a quarterly profit that surpassed analyst expectations, driven by the strong performance of its consumer goods and hotel divisions. The hotel vertical experienced a significant boost in revenue, nearly doubling to Rs 808.72 crore compared to the same period before the pandemic. This growth was attributed to the revival of leisure and business travel. Meanwhile, cigarette sales increased by 12.6% to Rs 8,082.26 crore, although the pace of revenue growth slowed compared to the previous quarter.

👉Zomato, the popular food delivery platform, released its financial results for the March quarter, showcasing significant improvements in its performance. The company reported a consolidated net loss of Rs 188.2 crore, marking a substantial reduction compared to the loss of Rs 359.7 crore in the same quarter last year. Zomato’s revenue from operations witnessed remarkable growth, reaching Rs 2,056 crore, a substantial increase of 69.66 percent from Rs 1,211.8 crore in the corresponding quarter of the previous year. The food delivery segment played a significant role, contributing Rs 78 crore to the EBITDA. Looking ahead, Zomato expressed its intention to achieve positive adjusted EBITDA and PAT (Profit After Tax) on a consolidated basis, including quick commerce, within the next four quarters