Sebi’s rules: Gain some, lose some Find out how the market regulator’s recently issued guidelines for the mutual fund industry will impact your investments.

The mutual fund landscape in India is undergoing rapid changes. The industry watchdog, Securities and Exchange Board of India, has ushered in a whole new framework for this investment avenue primarily to help revive a flagging industry. While industry players scurry to deal with the revised guidelines, fund investors need to be aware of the manner in which these steps will impact their investments. Will you need to alter your strategy due to these? Here's what the new regulations mean for you. 

Hike in expense ratio 
Sebi has allowed the asset management companies (AMCs) to charge an additional expense ratio of up to 0.3% on the daily net asset value (NAV) of the scheme, if the net inflows are received from locations beyond the top 15 cities. Expense ratio is the amount funds cut from a scheme's NAV every year as fund management fee, distributor commission and other operating expenses. AMCs will be able to charge this extra total expense ratio (TER) if the AUM collected from these places is more than 30% of the gross inflow. In case of lesser inflows from smaller cities, the proportionate amount will be allowed as additional TER. There is, however, a provision of reclaiming the additional TER charged if the money is redeemed within one year from the date of investment. Also, until now, the service tax charge on your scheme was borne by the mutual fund company. However, Sebi has now ruled that this will be passed on to the investors. 
How it impacts you 
The additional TER will be charged on the entire scheme corpus, not merely on the fresh inflows. So, Sebi is essentially asking the investors from the top tier cities to directly bear the cost of getting tier II cities' investors into the mutual fund fold. A 30 basis point (bps) increase in expenses can hurt your returns over the long term, especially if your scheme is not among the top performing ones. The top performing large-cap equity funds have delivered a return of around 10% over the past three years. A 0.3% cut in returns may not worry you much in this case. However, for the schemes that consistently underperform their benchmarks, this extra levy will be an added burden. Along with the service tax, these moves are expected to add around 0.4% to the cost. "Since the returns on debt funds are typically low, this additional charge will hurt these investors more. Equity investors may not feel the pinch in the long run," says Hemant Rustagi, CEO, Wiseinvest Advisors. 
    Single plan structure 
The regulator has mandated that all schemes, existing and new, be offered under a single plan. All existing schemes, with multiple plans based on the amount of investment (retail, institutional, super institutional, etc), will now have to accept subscriptions only under one plan. 
How it impacts you 
This means that all investors in a particular scheme will be subject to the same expense structure. This will do away with differential treatment for various categories of investors, and will also lead to a sharper focus on the fund manager. It also means that certain plans may be discontinued in favour of others. Some funds have chosen to stick with the retail option, while others have opted for the institutional plan. However, in the cases where the institutional plan has been chosen, the fund houses have brought down the minimum investment amount. The discontinuation of 
    schemes, such transactions will continue to be honoured till the investor has sufficient balance under the plan. "This single plan structure has affected debt fund investors more as hardly any equity schemes are offered under multiple plans," points out Srikant Meenakshi, director, FundsIndia. 
    Direct plan route 
While Sebi has done away with multiple plans under the same scheme, it has announced that each scheme will offer an equivalent direct plan. This alternate plan is for those who want to invest in the fund directly and not go through a broker or adviser. This plan will have a separate NAV, different from the normal scheme. 
How it impacts you 
A separate direct plan will take out a chunk of the cost a normal fund scheme has to bear towards the payment of distributor commissions. It is likely to take up to 0.75% of the expense ratio, which means a higher plans will not affect the existing investments made by people in these plans and they can redeem their holdings any time. Besides, where investors have set up either a systematic transfer plan (STP) or a systematic withdrawal plan (SWP) out of these NAV and better returns for investors over time. If you are comfortable enough to make investments without the need of an adviser or broker, you can shave off a significant portion of the cost by buying from the AMC directly. Says Pankaj Maalde, financial planner, Apnapaisa: "This alternate plan can lead to substantial savings for the investor. The 0.5-0.75% charge towards commission adds up to quite a hefty sum over time." 
    However, it will be your responsibility to choose the right type of fund, physically approach the nearest branch of the fund company to buy the same, monitor the performance and complete the redemption formalities. When you choose to go with an adviser, all these activities are taken care of for you, even though you have to cough up the extra 0.5-0.75%. Alternatively, you could approach a financial planner, who will provide the option of investing in direct plans by charging a fixed fee. 
Exit loads 
Most mutual funds charge an exit load if you redeem fund units within a year of investment. Earlier, the amount earned through exit loads was used by the AMC for marketing and distribution. However, Sebi has now ruled that the entire exit load will be credited back to the scheme corpus. It has also stated that an equal amount (capped at 20 bps) can be included in the expense ratio to compensate the fund company for loss due to outgoing investors. 
How it impacts you 
The rationale behind this move is to ensure that the existing investors will no longer be hit when others redeem their investments early. As the amount will be credited back to the scheme, the NAV will rise to that extent. However, as the regulator has simultaneously allowed fund companies to levy an equivalent charge as compensation for the outflow, the net effect remains the same. "For distributors, it means that the upfront fee that was coming from exit loads will go down. So there will no longer be an incentive to get investors to churn," says Meenakshi. 
    Defining advisers 
The regulator has defined the role and responsibilities of an investment adviser by enforcing a minimum qualification. From now on, all advisers, as defined by Sebi, will have to register with it and conform to the new regulations. They will only be allowed to charge clients a fee for their service and will not be eligible for commissions from companies on sale of products. 
How it impacts you 
These measures should usher in more transparency in the advisory services and help clients distinguish genuine advisers from product pushers. Since the adviser can now earn a fee from you but no commission from the AMCs, mis-selling may come down to an extent. The minimum certification, if properly designed, should also ensure quality of advice. 
Other measures 

• Small investors, who may not be taxpayers or have PAN and bank accounts, will be allowed cash transactions in mutual fund schemes up to 20,000. 

• The regulator will evolve a system of product labelling, that is, a categorisation mechanism that should help investors understand the different types of funds sold and enable them to make the right choice. 

• Internal limits in expense ratio have been removed and these will let fund companies allocate expenses in the manner they deem fit, within the overall cap. It is likely to lead to more aggressive promotional activities and higher distributor commissions. 

• Mutual funds have to annually set apart at least 2 bps on daily net assets within the maximum limit of TER for investor education and awareness initiatives. 
The verdict 
The most noticeable impact of the recent changes is that the investors will have to bear a slightly higher cost for investing in mutual funds. Dhirendra Kumar, CEO, Value Research, says, "All in all, investors could see a 0.1-0.4% increase in the fee that they effectively pay to have their funds managed. Any rise ends up reducing the returns that the funds generate." Rustagi adds another perspective: "Clearly, costs will go up, but investors should not deduce that this extra cost will take away the market risk. They need to look at performance in relative terms." 
    While there is an added burden on investors, there are some things to cheer about. The introduction of the costeffective direct plan, credit of exit load back into the scheme, product labelling for simplifying fund selection, and implementation of more strict investment advisory regulations are welcome from the investors' point of view. Meenakshi says, "These regulatory changes have not changed the investment proposition in any way. Mutual funds remain the most prudent vehicle for building wealth."

What experts say...

After the unveiling of Sebi's measures, the one question that investors are asking is, 'Am I better off or worse after these changes?' Let us assess this. 1. Introduction of direct plan: Since 2008, investors have been able to bypass the distributor and avoid the entry load. However, they still had to bear the burden of the trail commission as it was included in the scheme's NAV. The direct plan, with its lower expense ratio, is bound to aid self-directed investors. 2. Increase in expense ratio: While this is bound to raise the hackles of investors, it is not as bad as it appears. First of all, the additional TER of 30 bps is only applicable to the corpus raised from centres other than the top 15. It is not applicable to the entire corpus. So, the weighted average will be much lower. However, the hike in other expenses could hurt the returns to an extent. 3. Service tax: Luckily, this tax is levied only on the fund management charges, not on the entire expense ratio. So, the final impact on the investor should not be significant. 
    JAYANT PAI 
    Head, Marketing, 
    PPFAS Mutual Fund

At the heart of Sebi's reforms is the interest of small investors, particularly those residing in smaller towns. The mutual fund industry has been incentivised by allowing it to charge a higher fee, which is a part of the total expense ratio, in case the mobilisation from smaller cities is at least 30% of gross new inflows. All the AMCs will now make a concerted effort to promote their schemes in smaller cities to charge a higher TER and, thereby, improve their overall income. Sebi has also mandated that every AMC will set apart 0.02% of its net assets to be used for investor education and awareness initiatives. This comes to a healthy 150 crore booty. 
    Another important amendment is the treatment of exit load. The crediting of exit load in the scheme will increase the NAV and the returns of investors who are continuing in the scheme. This is specially beneficial for small investors who are vulnerable to the movement of funds by bigger investors. 
    RAJIV DEEP BAJAJ 
    Vice-Chairman & MD 
    Bajaj Capital