Mind your expenses

More than the quantum, it's the way expense ratios are configured which needs a rethink

- ASHUTOSH GUPTA

SEBI recently initiated a study of existing fees and expenses charged by mutual fund houses. While AMC bosses usually view such initiatives as another exercise in trimming expense ratios, I think SEBI should look at two other urgent issues that need fixing.

First is that AMCs are paying higher commissions for newer funds, potentially creating incentives for distributors to churn investors' money, a malpractice SEBI has worked hard to discourage over the years.

Second, higher commissions of new funds have led to exceptionally low expense ratios for their direct plans. While it may be a blessing for now, it will eventually impact directplan investors negatively once AMCs stop promoting these funds aggressively and reduce the commissions.

Both these matters have significant implications for you, the investor, and therefore must not be ignored.

Need for SEBI scrutiny

Before examining these issues more closely, let's begin with a more fundamental question: is SEBI really unfair in its unrelenting focus on costs? Well, even if the expense ratio is over-regulated, I think that's how it should be. While you normally expect market forces to take care of prices in a competitive and transparent industry, mutual funds, particularly equity funds, are a strange beast. Performance in this industry is such a big driver that if a fund does well, expenses don't matter - even if they are on the higher side. Conversely, if a fund doesn't do well, even lower expenses wouldn't count much. Therefore, the need for regulatory intervention to protect investors.

Without a tight regulatory leash, mutual funds could have easily gone the PMS or ULIP way. Do you remember they would charge as high as 6 per cent in the name of initial-issue expenses to launch a new fund? 6 per cent! If not for SEBI's heavy crackdown, the mutual fund industry would have been happily fleecing you to this day.