New Sebi norms to bar MFs from dumping investors with 'NAV management' fee

The chief of a large fund house sits late afternoon every day and dutifully pours over the net asset values (NAVs) of his schemes. After scrutinising the returns for the day, he decides on the expense ratios that need to be charged and deducted for each category.

The executive is not alone. In fact, many fund houses, especially those that handle significant institutional money, dabble in what some call "NAV management", which involves adjusting the expenses based on the returns made on the particular day.

The Securities and Exchange Board of India's (Sebi's) diktat asking fund houses to disclose the total expense ratio (TER) of their schemes daily, however, may put an end to this practice.

"So far, expenses were being changed at the whims of the fund houses. Investors can now get the actual returns rather than the accountants' returns added to the NAV," said the chief executive of a fund house, on condition of anonymity.

Added Vinod Jain, a distributor: "Funds will become a lot more thoughtful in deciding on what they can charge."

The total expense ratio (TER) is an annual charge deducted from the NAV daily. TER includes fund management charges, marketing and distribution costs, and R&T expenses, among others.

The impact will be felt more on the debt side where there is greater competition to attract large institutional money. "The norms will impact liquid funds more than anything else. Direct plans, where the charges are opaque, will also bear the brunt," said Jain.

As on January 31, liquid assets stood at Rs 3.81 trillion, about 13 per cent of the total MF assets of Rs 22 trillion.

This is how the expense play usually works. Suppose 8-10 bps is the cost of running a liquid fund. The fund house may reduce this to anywhere between 0-3 bps on days when the scheme performance is dismal. This is done to prop up returns.

On days when the performance is good, the expense is raised to recover the cost.

"Over the last few months, fund houses have reduced expense ratios for debt schemes impacted by the spike in yields. Sebi's new diktat will prevent this tinkering," said Kaustubh Belapurkar, director, fund research, Morningstar India.

Yields on the 10-year benchmark government bonds have risen 106 basis points to 7.53 per cent since the end of July.

Expenses for other debt categories also swing wildly. For instance, short-term funds may charge anywhere between 30 bps and 100 bps depending on the returns matrix. Income funds typically charge 75-150 bps but on days when returns are poor, fees can go as low as 40-50 bps.

TERs are charged as per a slab-based formula. For equity schemes, the maximum TER that a scheme can charge is 2.5 per cent for the first Rs 1 billion, 2.25 per cent for the next Rs 3 billion, and so on. This excludes the additional 30 bps for assets accrued from B15 cities and 20 bps for ploughing back exit loads. AMCs, however, are free to charge any fees within this limit.