In the last one year, there have been some key changes in mutual fund regulation. These were on the anvil for a long time and the regulator has finally moved into auctioning these announcements. Here are four such measures that have been announced in the last 1 year to further ensure transparency and protect the interests of mutual fund investors in India.
Regulation of Total Expense Ratio (TER) of mutual funds:
During the year, the SEBI has come out with clear guidelines for equity funds and debt funds on how the total expense ratio can be charged. The total expense ratio is the total cost that is debited to your NAV for marketing and managing the fund and includes administrative costs like registry costs, transaction costs, management costs, establishment costs, promotional costs etc. The upper ceiling for TER has been defined as under:
The range of AUM TER for Equity Fund TER for Debt Funds
Up to Rs.100 crore 2.50% 2.25%
Rs.101 crore to Rs.400 crore 2.25% 2.00%
Rs.401 crore to Rs.700 crore 2.00% 1.75%
Above Rs.700 crore 1.75% 1.50%
The TER will be calculated on a graded basis. For an equity fund with AUM of Rs.1000 crore, the cost structure will be a TER of Rs.20.50 crore or a TER of 2.05%. There are two catches in this measure. Firstly, funds can charge 30 bps higher if at least 30% of your flows during the year come from outside the top-15 cities in India. Secondly, fund managers need to pay GST on their management fees and that can be billed separately in the TER outside this range. Effectively, for equity fund with an AUM of Rs.100 crore with more than 30% from non-urban centers will have a TER of nearly 3.25% including the GST on management fees. The big difference for the investor is the transparency as the fund is now required to disclose the TER debited to the NAV on a daily basis.
Taxation of LTCG and dividends on equity funds:
The Union Budget 2018 made two important announcements pertaining to the mutual funds (special focus on equity funds). Firstly, the capital gains on equity funds effective from April 1st, 2018 will be taxed at 10% above Rs.1 lakh per year. Even if you sell your equity fund after 10 years, there will be no benefit of indexation available to you. This is likely to work against the investor. Dividends declared by equity funds were tax-free in the hands of the investors and did not attract dividend distribution tax (DDT). While dividends by equity funds will continue to be tax-free in the hands of the investor, post-April 2018 all equity fund dividends will attract DDT of 10% which will be deducted by the fund.
Changes in scheme categorization
This is, perhaps, one of the biggest and most far-reaching changes as far as mutual funds are concerned. In the past, mutual funds were permitted to literally give any name to their fund and more often than not had multiple funds with the same characteristics but different nomenclatures. For example, Birla AMC would have 7 diversified equity funds with the same portfolio characteristics but different names. This not only confused the investors but also made the fund mix of an AMC unnecessarily complex. The SEBI has not defined a total of 34 categories and all funds have to fall under these categories. Also, an AMC will only be permitted to have one fund per category and all similar funds will either have to be consolidated or wound up. More importantly, the fund portfolio will have to live up to its name. Any equity diversified having more than 95% in the Nifty stocks will be reclassified as an index fund and will therefore be eligible for lower TER only. This move is likely to bring a lot of transparency in fund classification and make life easier for investors and for financial advisors too.
Measure returns using the Total Returns Index (TRI)
Another major step towards transparency in the last one year was the move towards the total returns index (TRI) when it comes to benchmarking the returns against an index like Nifty and Sensex. Let us understand this in greater detail. Currently, Nifty returns are expressed in absolute terms. For example, Nifty has gone up by 12% in the last 1 year in absolute terms. Assume that the equity fund (growth plan) you are holding is up by 15% in the last one year. You will conclude that your fund has outperformed the index by 3%. But there is a flaw in the argument.
The Nifty returns are without considering the effect of dividends but the fund has received dividends which are reflected in the NAV. So, you add the dividend yield to the Nifty returns. If the dividend yield was 2% for the year, then your Total Returns on Nifty is not 12% but 14%. That means your fund has outperformed the Nifty by just 1% and not 3% as stated earlier. Shifting to the TRI has been made mandatory for all funds. This is likely to make the mutual fund reporting a lot more transparent.
In a nutshell, the regulator has made an effort to bring more transparency to mutual fund reporting and make things easier for the investors to understand. Surely, a step in the right direction!
Invest in Direct Mutual Funds and save up to 1.5% on Distributors Commission