The Evolving Frontier: Understanding Mutual Fund Fees for Indian Investors

Investing in mutual funds has been a preferred avenue for Indian investors looking to grow their wealth. But growing the wealth is not entirely free.

This guide looks into the changing dynamics of mutual fund fees in India, helping you understand the basics to make informed decisions.

The fundamentals of mutual fund fees 

There are two types of fees that mutual fund houses charge for operating and managing any mutual fund that are regular plans. A regular plan is when an investor invests in a mutual fund through a distributor or an agent.

These are:

Expense ratio

This denotes a percentage of a mutual fund’s total assets which the investors must pay annually. It includes several costs such as fund management fees, administrative expenses, and miscellaneous operational costs. For example, if a mutual fund has an expense ratio of 1%, an investor with a ₹20,000 investment would pay ₹200 every year.

Exit Load

Exit load refers to fees charged to investors who redeem their mutual fund units before the specified holding period expires. In most cases, that period is one year. For instance, a fund may have a 1% exit load if units are redeemed within the first six months.

Exit loads exist to discourage short-term investment and motivate investors to stay in for a longer duration. 

The rise of direct plans

Over the years, direct plans have come up as a substitute for regular plans. 

As the name suggests, a direct plan allows an investor to invest in a mutual fund directly. There are no intermediaries involved. Consequently, the management and operational costs are lower, resulting in a lower expensive ratio. 

Suppose the same mutual fund is available as a regular plan and a direct plan. Under the regular plan, the expense ratio may come up to 1.5%, whereas the expense ratio of a direct plan could be as low as 0.75%. The substantial difference in the expense ratio can impact the returns over time. 

In most cases, those investing via direct plans risk being responsible for their investment decisions. Seasoned investors may feel at home with this arrangement but a novice investor may find it daunting. In such cases, one may opt for professional guidance and regular plans to ensure better investment decisions. 

SEBI’s TER reforms: Impact on mutual fund fees

The Securities and Exchange Board of India (SEBI), the securities market regular, has played an important role in regulating the mutual fund fees landscape.

 SEBI capped the TER at 2.25% for equity funds for the first INR 500 crore of net assets and 2% for debt funds for the first INR 500 crore of net assets. The ratio decreases progressively with the corresponding asset size. The exit load of open-ended schemes was fixed at a maximum of 5%.

In May 2023, SEBI announced that equity and debt funds should charge a uniform expense ratio from the investors, irrespective of the asset size. This marks a departure from the current mechanism which permits each scheme to levy a distinct TER based on its specific asset size. As per the proposal, SEBI wants the funds to charge a maximum TER of 2.55% for equity assets under management below ₹2,500 crore. The TER decreases as the asset base increases.

As per SEBI “the revised TER slabs are proposed ensuring small AMCs are not at a disadvantage, and to encourage competition amongst AMCs of all sizes, which will be in the interest of investors.”

For Hybrid and Solution Oriented schemes, SEBI wants the TER to be determined basis the weighted average of the TER for equity and equity-related instruments and the TER for assets other than equity and equity-related instruments.

SEBI also proposed that it didn’t want investors to make direct payments for upfront commissions and deduct transaction costs from their investments. Instead, all expenses including brokerage and GST need to be included within the TER. The exit load for open-ended schemes was also proposed to be lowered to 2%. 

However, in June 2023, SEBI deferred the decision to charge uniform TER. 

Wrapping up

The landscape of mutual fund fees in India is transforming, presenting both challenges and opportunities for investors. By staying informed about the actual cost of investments, investors work towards achieving their financial goals. Remember, informed decisions are critical for building a financially secure tomorrow.