Mutual Fund reforms are going to impact you from Oct 1st 2012

If you noticed government is on 5000 horse power engine from last couple of days. They took risk of announcing FDI in retail, curtailing subsidized cooking gas & went ahead with diesel price hike – irrespective of pressure from coalition parties. I always wonder why politicians are not asked to study economics (or may be a mandatory crash course in basic economics before taking oath) – Mamta Banarjee should realize that subsidies are anti-growth of an economy; removing subsidy leads to optimum utilization of resources. I think it’s too much to expect this from politicians.

Let’s comeback to Mutual Fund Reforms – after presidential election, Chidambram was again back on the hot seat of finance minister (in fact market experts and masses cheer for him). And surprisingly Prime Minister’s first command to Chidu was for reforms in Mutual Fund sector. In fact he attended one of the prelims meeting and also acknowledge that the mutual fund industry need to be re-energized. This shows that Mutual Funds are important part of overall financial system & changes are required to make MFs a household name.

Do you know 29% of American households invest more than 50% of their financial savings through mutual funds? But if we talk about India – hardly 1% have ever invested in Mutual Funds. Let’s see what new reforms intend to offer you as an investor – beginning with the bad news.

Bad News – Increase in expenses

In August 2009 SEBI scraped entry load from mutual funds to reduce excessive churning – but this severely impacted earnings of all distributors. Number of active distributors came down from 70000 to less than 20000. So SEBI announced slew of measures to bring in reforms in Mutual Fund Industry, few of which may hurt you as an investor.

Earlier total expense ratio was 2.5% but after 1st Oct 2012 it can go up to 3%. Overall expense ratio may increase by 0.3% to 0.6% including 0.2% additional expense in lieu of exit loads, 0.3% incentive for reaching beyond 15 cities and 0.1% as service tax. SEBI named this “Steps to RE-ENERGISE Mutual Fund Industry”, so definitely someone will have to pay for this energy drink. This is bit surprising as across the globe financial products are shedding their expenses – making them more slim-trip & light on investors pocket.

Note: Actual Expense of fund depends on the size – in current scenario Rs 100 Crore fund can charge maximum 2.5% but Rs 2000 Crore fund will only charge 1.9%.

Mutual Funds News

Good News

Don’t feel sad – there are lots of positives to cheer which will improve the things in long term.

Exit Loads: If you have invested in mutual funds, you must be aware about exit loads. Normally in equity schemes there is exit load of 1% for 1 year so if someone redeems before 1 years, AMC will deduct 1% from redemption proceeds. But why exit loads are added to schemes? Because if lot of investors keep buying & selling units it will impact performance of fund – fund managers always invest keeping in mind a long term period but their strategies are impacted if they are not sure of tenure of funds that they have.

But have you ever wondered where this amount goes, actually this amount is used to pay commissions to distributors – which defies the purpose of exit loads. But from now onwards Exit loads will be added back to scheme which  will also reduce some impact of increased expenses.

Product Labeling: There are more than 300 equity scheme & this creates confusion in the mind of investor. Even if there selection criteria is just performance, is it wise to compare a large cap fund with mid cap fund? Now SEBI is making it mandatory that a fund should be classified by AMC according to his investment style & this should be mentioned in all marketing & client communication. This will simplify the choice for investors.

Strict rules in case of Mis-selling: Mis-selling is rampant in all personal finance products. Financial products are not durable products, where someone can see, feel & compare the things – it’s all about future promises, so mis-selling is very easy. New MF reform makes mis-selling a fraudulent and unfair trade practice – as penalties for frauds are far more serious than those for breach of code of conduct.

More money for Investor Education: Mutual Fund reform talks about assigning 0.02% from expense ratio for investor education that becomes decent money when we talk about Rs 7-8 lakh crores corpus managed by mutual fund industry.

New distributor class: As I mentioned in the starting that MF distributors are going extinct – “only 1000 tigers left” joke is floating in MF industry. Till date MF distributors have to compulsorily clear NISM exam & register with AMFI (Association of Mutual Fund in India) – this is further renewed every 4th year. But now SEBI issued guidelines that even retired bankers & teachers can sell mutual funds without exam or registration. Though they will able to sell limited product which are simple to understand both by advisor & client – consistent performance is one of the criteria.

Direct Plan (applicable from 1st Jan 2013): Right now funds have 2-3 classes like retail, institutional & super institutional – categorization is done on basis of investment size & the only difference is expense ratio. Now SEBI has asked mutual funds to have only 2 classes – normal & direct. Introduction of new direct class means that if someone directly invest with Asset Management Company, he will be paying less expenses – may be 0.5% to 1% differential. So it is good for DIY (Do It Yourself) clients where decrease in expenses will improve their returns. But is Direct that easy choice? Read this

“According to Baron’s, In the 20 years between 1988 and 2008, the typical American equity mutual fund averaged 8.4% per year, or 402% overall. The average investor, however, made just 1.9% per year, or 46% overall. “

Do you think Indian results will be different, considering the very low Financial Literacy levels in India??

Another Good News Coming Soon

This is not directly related to current mutual fund reforms but is part of bigger vision of SEBI. All Investment Advisors (including financial planners) who charge fees have to be registered with SEBI & will be regulated. This is indeed a welcome step. Exact details will be shared by SEBI shortly, but this will make your job as an investor easy while  selecting professional registered advisors.