VISHAL KRISHNA & ABHISHEK CHOWDHURY
Two years ago, Shreedhar Raju, 27, decided that he had to make quick money. So, he invested a part of his hard-earned wages in a new open-ended mutual fund, where he could withdraw his investment at any given point of time. He was, then, unaware that he had paid 5-6 per cent as distribution expenses, charged by the distributor or the financial intermediary, who sells the fund on behalf of the mutual fund company. But over a cup of tea, it occurred to him that he had ignored a simple, but crucial rule. He realised that he had incurred expenses up to 7.25 per cent over a year on the total investment made, which included 2.25 per cent as management expenses along with distribution expenses of 5 per cent.
India’s distribution expenses for mutual funds, for which data is not available, “is very high”, say analysts. They attribute this to the large number of schemes in the Indian market. Well over 1,115 in number, these schemes are mostly managed by the top 10 fund houses in India, according to OptiMix, an investment solutions firm. “There should be an increase in the household savings market, which should participate in the mutual fund industry,” says Mugunthan Silva, chief investment officer (CIO) of OptiMix in Mumbai. “At the moment, only 3 per cent of the household market participates in mutual funds.” The Indian household savings participating in mutual funds is about $8 billion (Rs 32,000 crore).
When the Indian mutual fund industry is compared with that of Australia’s massive $1-trillion market, management expenses are higher by up to 7-8 per cent. But the latter’s returns are higher too because of the sheer size of the market, say fund managers. Also, the number of schemes in the market are less than 500 and there are around 70-80 fund houses. In India, there are 32 fund houses managing over 1,000 schemes. Here, the returns are less and because most of these schemes are new funds, the expenses incurred by an individual are higher. “In a mature market, the distribution costs are lower,” says Mugunthan. “In India, this would happen only when the funds under management grow substantially.”
Analysts from CRISIL explain why distribution expenses are high in India. Although management fees charged are on a par with those in most European nations (See ‘Who’s The Costliest Of All’), the number of new funds released in India makes distribution expenses high.
“The investor will be better off without the 5-6 per cent distribution charge, which a number of open-ended new fund offers (NFOs) are charging,” says Krishnan Sitaraman, CRISIL head of fund services and fixed income. “The distribution charges in the US would be less than 5 per cent. At the same time, if one invests in an existing scheme in India, rather than an NFO, the deductions are much lower.” Krishnan says these 32 fund houses are together tapping only about 4 per cent of the incremental household savings market on an annual basis. There are many versions amidst the fund management fraternity saying that India is the cheapest market in the world. But when it comes to the distribution expenses, it’s a completely different story. Analysts say that there are too many schemes chasing very few investors and as investors skip from one scheme to another, their expenses rise.
More close-ended schemes are increasingly being launched after the SEBI set guidelines last year for not allowing for amortisation, where initial expenses on a fund are knocked off over a number of years, in open ended schemes. “Low penetration in the household savings market, combined with more investment in long term funds will reduce distribution expenses for the individual,’’ says Krishnan. According to CRISIL, only top five asset management companies (AMCs) in India accounted for about 52 per cent of the mutual fund market and the Indian mutual fund industry forms only 0.37 per cent of the globally managed funds in the mutual fund industry, which is $23 trillion. The reason for this was largely the lack of geographical penetration in the industry with a substantial portion of the assets under management (AUM) coming from the larger cities.
But the reason why fund houses charge high distribution fees is that the average Indian investor hangs on to a mutual fund as a tax saving benefit for a short period. Therefore, by investing in many new open-ended schemes, expenses were generally higher and stood between 6-7.25 per cent of the investment. “Most of these investments are in open ended equity funds and Indian investors are in mutual funds for not more than a year or so,” says Mugunthan. “Such individuals, investing in many funds, do not realise that their expenses would have gone up.” This mentality of short term investment has been one of the causes for the birth of new fund offers and schemes.
Analysts believe that investors should lock in their funds for at least 3-5 years to get better returns. They believe that the asset base of mutual funds in India would increase over the next five years to Rs 10 lakh crore with 50 per cent investment in equity. They are placing huge emphasis on educating individuals in tier-II cities so that mutual fund investment is considered more as a long term investment.
Similarly, index funds and exchange traded funds (ETFs) have not found favour in the Indian market. ETFs are cheaper with 0.6-1 per cent as annualised total expenses and are relatively new in the Indian market. Also, the SEBI has recently capped the maximum expenses that can be charged by an index fund at 1.5 per cent of total assets. Till date, the figure was fixed at an upper limit of 2.5 per cent, in line with any other equity fund. Compare this with the US, and one will find that these expenses are cheaper. The average expense ratio for US index funds is 0.70 per cent and ETFs is 0.34 per cent. In India, the expenses for index funds stand at 1.10 per cent. “Led by Vanguard, index funds in the US have more than $1.7 trillion of AUM, while in India just Rs 375 crores are in index funds,” says Ajay Bagga, CEO of Lotus India Asset Management Company. “Similarly, ETFs are taking off globally, with assets worth nearly $500 billion (Rs 20 lakh crore) in ETFs now.” In India, ETFs total to Rs 6,090 crore, the largest chunk of which comes from banking ETFs, which manage Rs 5,845 crores in assets (See ‘India’s White Elephant’).
However, industry sources mention that the entry and exit loads were the cheapest in India when compared to open-ended international funds, where entry loads could go up to 5 per cent. “Indian stockmarkets have given a return of nearly 18 per cent on a compounded average basis for the past 15 years,” says Sandip Sabharwal, CIO, JM Financial Asset Management. “The current load structures should not be an impediment for investors.” He also points out that only investors who stayed longer in mutual funds have had healthy returns and, further, he compares this to India’s bull run since 2003. However, most fund houses declined to comment on the high cost of distribution expenses and the need to reduce the number of schemes that are present in the Indian mutual fund market today.
“Although a lot of structured products or schemes can be designed to suit the need of individuals,” says Sabharwal, “there is a need to allow household savings into the mutual fund market. Only then can one compare the Indian market to other developing markets.” Fund managers feel that introducing new products would not work in a market like India. Instead, they want the understanding of basic products to catch up first.
