Sebi proposes uniform expense ratio for mutual funds to curb mis-selling

The Securities and Exchange Board of India (Sebi) is proposing to change the way mutual funds charge investors total expense ratio – the annual fee that these asset managers collect from unitholders – as it looks at ways to further clamp down on mis-selling, said two people familiar with the development. The capital markets regulator may ask mutual funds to make expense ratio uniform for scheme categories such as equity or debt, said one of the two people.

This means a fund house, for instance, will have to charge the same expense ratio for all its equity funds if this proposal goes through. So, if a mutual fund manages ₹50,000 crore in equity assets across 10 schemes, all of them must have the same expense ratio. Mutual funds currently have the flexibility to fix this fee as per the scheme.

The proposal has been put forward after Sebi found that a chunk of the investments in equity New Fund Offerings (NFOs) in recent years were pulled in from existing schemes. The regulator suspects various mutual fund brokers and distributors pushed clients to shift money from existing investments to new schemes to earn higher commissions, the person said.

Sebi didn’t respond to queries.

The thinking behind the latest Sebi proposal is that if the expense ratio is made uniform for all equity schemes, it would prevent distributors from asking clients to shift money across products, including new schemes, just for higher commission, thereby minimising mis-selling.

According to industry estimates, over 20% of the industry’s assets under management at the aggregate level last year moved into the costlier equity NFOs.

Currently, the expense ratio – including fund management fees, marketing fees and distributor commission, among others – charged by mutual funds varies by product. Within equities, it is different for scheme categories such as large-cap, flexi-cap and mid-cap among others. The expense ratio also depends on various other factors such as fund size and type of the fund. “The trail fee (paid by mutual funds to distributors for investments retained) for older equity money is about 0.25%, while in the case of recent NFOs, the fee was as high as 1.5%,” said the person cited above.“Distributors would have recommended clients to book profits under the pretext that older schemes are not doing well and the NFOs are presenting better opportunities.”

The fee that distributors receive from mutual funds depends on the expense ratio. Commissions tend to be higher when mutual funds’ expense ratio is more. In regular plans, the expense ratio charged by mutual funds also includes distributor commissions.

The maximum total expense ratio chargeable by an equity scheme is 2.25%, according to Sebi’s framework.

Talk of Sebi looking to alter norms on total expense ratio has been doing the rounds since December when the regulator announced it had initiated a detailed study of fees and expenses charged by mutual funds. The regulator said the study will seek to provide data as “input for policy formulations”.

Sebi had last changed the expense ratio framework in September 2018. Since then, the mutual fund industry’s assets under management have risen by almost 65% to 40 lakh crore on December 31, 2022.

The regulator has felt that there is further scope to reduce the total expense ratio of mutual funds, making them cheaper for investors.

“What we have gathered is that mutual funds should make more money by gathering more assets and make it the volume game,” said a senior mutual fund industry official.

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