How SEBI's Plan To Levy Performance Based Fees On Mutual Funds Can Affect Your Investments

India's market regulator Securities and Exchange Board of India (SEBI) is considering at least two structures for mutual funds to charge a product outperformance fee from investors. The options that the capital markets regulator is looking at involve introducing fixed and variable fee components but they may be subject to regulatory caps.

SEBI Planning A Performance Based Fees

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One of the structures that SEBI is considering is to have a Base Total Expense Ratio (TER) and then allow mutual funds to charge performance fees over and above this. TER is the overall fee that mutual funds charge investors every year.

SEBI's thinking seems to be that the Base Total Expense Ratio for a scheme could be "half of the actual TER limit or actual cost excluding management fee, whichever is lower," according to a person familiar with the plan, as per ET report. So, if a scheme is charging a Total Expense Ratio of 2.25% - the highest fee that an equity scheme can collect from investors - the mutual fund, under this proposed structure, would be permitted to charge 1.125% as base TER.

Depending on the scheme's ability to beat the benchmark, the fund could be allowed to charge up to 1.5 times the Base Total Expense Ratio as performance incentive, said the person cited above. So, if an equity scheme's base TER is 1.125% and it charges a performance fee of 1.5 times base TER on superior returns, the total fee that the fund can charge the investor is about 1.7%. The fund, however, can charge investors a performance incentive only on redemption from the scheme.

Another option that SEBI is considering is to allow mutual funds to charge the normal Total Expense Ratio. So, if the TER chargeable by the equity scheme is 2.25%, the fund house would collect this entire fee. Here too, the performance fee can be charged only on redemption. When the investor pulls money out of the scheme, the fee will be calculated based on the product performance. If the scheme has outperformed the benchmark, the fund can retain the fee. In the event of under-performance, the fee collected by the fund must be repaid to the extent of the returns at the time of redemption.

The underlying factor in both these options is that the performance fee can be finalized and charged only on redemption by investors.

SEBI is reportedly in the process of putting together a discussion paper on this matter that will seek the feedback of the industry and other market participants. Last week, a top SEBI official said that a working group has been set up to see if performance fees can be introduced for the industry. Since then, the industry has been abuzz with speculation on the likely structures of such performance-driven incentives and how they may impact MF houses and investors.

Also Read: 85 Lakh Millennials Started Investing In Mutual Funds In Last Five Years

Experts Don't See Much Benefit For Investors

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Experts are of the opinion that a new performance-based fee structure will complicate things for both investors and MF houses. Dhirendra Kumar, Chief Executive Officer of Value Research, meanwhile, believes that the biggest issue is that there is no reasonable way of implementing this in open-ended funds that is fair to investors.

¡°In theory, performance-based fees sound like a good idea. If a fund makes more money for its investors, it gets to earn more. At a cursory glance, it looks like a good incentive system that will encourage funds to perform better. Whether it actually functions like that will be a challenge,¡± he added.

Experts feel that implementing performance-based fees may be a big challenge in case of open-ended mutual funds, as per Moneycontrol report.

¡°If a fund starts doing well, it will attract more investors. Better performance will mean that the fund can start charging a higher fee. It will charge higher fees from those who invested in the scheme after looking at the out-performance. But then, these new investors haven¡¯t seen the out-performance. So the question is, when will you charge more for out-performance, after or before. To be fair and equitable among all investors, expenses must be charged on a daily basis as investors keep getting in and out of an open-end fund every day. Hard to see how this can be made to work,¡± said Kumar.

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¡°This is over-regulation. If you look at global markets, only the UK and the US have performance-linked fees for mutual funds. Just because active funds are under-performing the index, the regulators are looking to introduce this,¡± said Kirtan Shah, founder of Credence Wealth Advisors LLP.

On the other hand, Shah said, ¡°If something like what prevails in some global markets is introduced in India, then the investor community might end up paying slightly more if the fund is outperforming.¡±

Also Read; Benefits Of Investing In Mutual Fund Through SiPs

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