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One of the least known aspects around mutual funds are the charges levied by the fund houses and the motive of this article is to shed some light on the types of charges which a fund house levies. Broadly, there are two types of charges – Entry / Exit loads and Annual Recurring charges.Expense Ratio

 

Entry & Exit Loads

Entry Load

Till mid 2009, most of the mutual fund purchases were subject to an Entry Load which was an initial charge being deducted from the amount invested by the investor. For example, if you invested Rs. 100, an Entry load of approx Rs. 2.5 was deducted and the remain Rs. 97.5 was invested. This entry load used range from 0.5% to 3%, with most of the equity oriented mutual funds charging around 2.25-2.5% intial Entry load. This entry load was in essence passed on to the mutual fund distributors as sales incentives and hence used to negatively affect the investor. From 2009 onwards, Entry Load has been abolished and has been very welcomed by the entire investor community, though the mutual fund distributors got a big hit in terms of their revenues.

Exit Load

While entry load was abolished, the fund houses were allowed to charge an Exit load. This charge is generally upto 1% of the value for most of the open ended funds and is levied if you want to sell your invested fund within 1 year from the date of purchase. For example, lets say you invested Rs. 100,000 in a mutual fund on 1 January 2011 and wanted to sell your holdings in the funds on 30 June 2011 when they were valued at Rs. 125,000.  The fund house shall deduct 1% of the value of the holding (1% of Rs. 1,25,000) i.e. Rs. 1,250 and shall provide you Rs. 123,750. This Rs. 1,250 is termed as Exit Load. If you sold you investments after 31 December 2011, the fund house will not charge you an exit load. Some close ended funds charge Exit Load in slabs over a period of 3 years. Most of these charges for these close ended funds are indicatively as follows:

  • Sold before 1 year – 3%
  • Between 1-2 years 2%
  • Between 2-3 years 1%
  • After 3 years – None

The reason behind Exit Loads is to discourage investors to sell their holdings in short term and promote the culture of being long term investors.

 

Annual Recurring Charges

Each Asset Management Company (AMC) charges an annual recurring charge in return of managing the funds in a scheme. The AMCs are by law required to limit their overall annual charge within the overall guidelines as specified by the regulator (SEBI). These guidelines mention the maximum charges which an AMC can charge to a mutual fund scheme based upon the size of the fund and are as follows:

Average Weekly Assets Equity Funds Debt Funds
First 100 crores

2.50%

2.25%

Next 300 crore

2.25%

2.00%

Next 300 crore

2.00%

1.75%

Balance Funds

1.75%

1.50%

To understand how this work, we have an illustration. In the table below, the first row reflects the average value of assets managed by an Equity fund and the next set of rows reflect the overall charges being computed based upon the overall size of the fund.

   

Average Size of the Fund (in crores)

Average Weekly Assets Equity Funds

500

1000

2000

3000

4000

5000

First 100 crores

2.50%

2.5

2.5

2.5

2.5

2.5

2.5

Next 300 crore

2.25%

6.75

6.75

6.75

6.75

6.75

6.75

Next 300 crore

2.00%

2

6

6

6

6

6

Balance Funds

1.75%

5.25

22.75

40.25

57.75

75.25

Total Charges (in crores)  

11.25

20.5

38

55.5

73

90.5

Average Charges (in %)

2.25%

2.05%

1.90%

1.85%

1.83%

1.81%

Charges applicable to Rs. 10,000 investment

225

205

190

185

182.5

181

It is interesting to note that the larger the fund size, the smaller is the overall charge ratio for the fund. For example, the fund managing just Rs. 500 crores would be charging Rs. 11.25 crores per year which is 2.25% of its fund value. While, the fund managing Rs. 5,000 crores worth of asset would be charging Rs. 90.5 crores per year, which is 1.81% of its fund value.  The last row of the above table shows that an investment of Rs. 10,000  in a fund which is managing Rs. 500 crores of assets would attract Rs. 225 per year of charges, while the same investment in a fund managing Rs. 5000 crore worth of assets would attract Rs. 181 per year of charges. Hence you may appreciate that the annual recurring charges forms one of the important basis of selecting a fund as these charges have a material impact over a long period of time.

 

Purpose of  Annual Recurring Charges

This is a very contentious topic as the fund houses are heavily regulated by SEBI in what they can charge the unit holders out of the annual recurring charges. There is a specific list of items which can be charged and is clearly specified by SEBI under its circular. Broadly the list of allowable expenses are as follows:

  1. Fees for various service providers such as Trustees, AMC, Registrar & Transfer agents, custodians, etc.;
  2. Audit fees paid to the auditors;
  3. Selling expenses including commissions paid to the distributors and advertisement expenses;
  4. Investor servicing expenses such as investor communcation, account statement, dividend / redemption / warrants cost;
  5. Listing & Depositor fees;
  6. Service Tax.

The circular also specifically mentions that the following expenses can not be charged to the schemes of mutual funds:

  1. Penalty and fines for infraction of law;
  2. Interest on delayed payments to unit holders;
  3. General Legal, marketing, publication expenses not attributable to any scheme;
  4. Fund accounting fees;
  5. Depreciation on fixed assets and software costs;
  6. General Administration & Corporate advertisement & infrastructure costs; and
  7. Expenses on investment management / general management of the AMC.

The full circular can be viewed at http://www.sebi.gov.in/cms/sebi_data/attachdocs/1295932761762.pdf

 

But I don’t see the charges in my Account Statement !

True ! In line with the approved and accepted accounting policies, the fund houses deduct the fund management charges from the value of the fund before publishinng the Net Asset Value (NAV) of the respective scheme. Let me show this with an example to make it more clear.

Lets assume a fund which was initially started with Rs. 100,00,000 value, broken down into 10,00,000 units. Hence the starting NAV for the fund would have been Rs. 10 per unit. Assuming that the market value of the fund is now Rs. 120,00,000 and the annual charges are Rs. 240,000, the NAV would be computed as follows:

Fund Value              : Rs. 1,20,00,000

Less fund charges : Rs.          240,000

Net Fund Value     :  Rs. 1,17,60,000

Net Asset Value    :   Rs. 11.76 per unit. (arrived at by dividing Net Fund Value by Number of Units : 1,17,60,000 / 10,00,000)

Hence you may notice that the fund houses present the value of their funds after deducting the charges and hence the NAV is also computed after charges. You would notice in your account statement the NAV of Rs. 11.76, but the charges of Rs. 0.24 per unit would not be shown.

 

Are the Fund Charges Justified ?

No one likes to pay out charges but hey nothing comes for free ! In true spirit, this is a cost of investing. Even if you invested your funds directly into equity market, you would have incurred direct costs of making such investments such as Brokerage (ranging from 0.25% to 0.75%), Demat Charges (ranging from free to Rs. 50 per script purchased or sold), administrative and research costs. Despite of that attempt, you may not be able to achieve a good diversification as your limited funds may not allow you to do a good diversification. Even your research may be limited to market news, rumours and may not be able to capitalise upon proffessional researches and insight from the respective Company’s management (I am not referrring to insider news).

Hence if you see the number of benefits which come under the wrapper of Mutual Funds, it should not be of much concern to pay mutual fund charges which in return provides an opportunity for your investments to grow and create wealth in the long term !

 

You can contact the author of this article – Banyan Financial Advisors via their website www.banyanfa.com.

 

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