Of all An economic downturn, lost jobs, uncertain market conditions, higher prices?we have a number of things to complain these days. But if there is one thing that we have no room for complaining about, it is the effort of the Securities and Exchange Board of India (Sebi) to enhance transparency for the Indian mutual fund investors.
Over the last few months, Sebi has passed various regulations that aim at benefiting particularly the small investors. The most recent ones have been the abolition of entry load for mutual funds and synchronisation of exit load. The latter will go a long way in ensuring that small investors are treated at par with larger investors by fund houses. The new rule will even bring about a major change in investor behaviour as well.
Like in almost every business, the bigger customer is given preference in the mutual fund business as well. For any business, a bigger customer means lower costs and higher margins. What further increases the preferential treatment is the fear of the bigger customer taking his business away elsewhere, and with it a large chunk of profits.
All of these factors play a role in the mutual fund business too. Big investors have had to pay lower or zero entry and exit loads. For certain amounts?generally over Rs 1 crore?funds would charge no exit load. But now, this preferential treatment has been banned by Sebi. First came the entry load abolition, and now Sebi has passed rules to make a couple of corrections to exit loads.
Exit loads are vindicated because of two primary reasons. Firstly, a fund company has to spend money to attract investors and hence should be compensated in case of an early redemption. And secondly, when an investor?particularly a big one?exits a fund, he harms other investors? investments as well. Sebi?s new rules amend both of these concerns. Now, fund companies can take up to 1%of the exit load as marketing expenses and the rest of the load charges must be credited back to the fund?s NAV, which is in effect giving it back to the remaining investors.
When a large investor redeems a big amount, it damages the interests of other investors in a big way. And large investors do this often to chase short-term investors because they don’t have to pay any exit load. This practice affects small investors because when a big amount is taken away from a fund, the fund manager tends to sell the better quality shares that are more liquid. It goes without saying that this adversely affects the fund?s performance. And hence, the second part of Sebi?s new rule is spot-on.
While the new rulings could well stop large investors from frequent churning, they have put fund companies in a quandary. Fund companies are worried that large investors would stop investing in equity funds or may insist on separate low-cost institutional funds. While this may happen in some cases, I feel that on the whole no large investor will completely shun mutual funds only because of exit loads. In any case, Sebi?s reforms are totally justified and were long overdue. The ?mutuality? factor of mutual funds was almost forgotten, of which, equal loads is an important part.
