Asset management companies (AMCs) have been left stumped, with the Securities and Exchange Board of India (Sebi) once again proposing that fees charged by MF schemes be linked to their performance.
The regulator, which first floated the proposal earlier this year, has once again sought public opinion in its recent consultation paper on a uniform total expense ratio (TER) structure for fund houses.
The proposal to link fees charged by MF schemes to their performance vis-a-vis the benchmarks, is picking up pace owing to the regulator’s observation that close to 73% of schemes (regular plans) had underperformed the benchmarks on a five-year basis till February.
On a 10-year basis, the figure stood at close to 60%, shows Sebi’s analysis. Under direct plans, 55% of schemes underperformed over five years, with 34% underperforming over a 10-year horizon.
Against this backdrop, Sebi believes fund managers should charge fees from investors only if they manage to outperform the benchmark. Rising investor concern over underperformance by the benchmarks and rising volatility in the equity markets have pushed investors towards passive schemes in recent times.
These are low-fee and low-risk schemes such as exchange-traded funds (ETFs) and index funds, in which the scheme looks to mimic the performance of the underlying benchmark.
“It is difficult to see this taking off, as fund houses will be reluctant to lose revenue based on performance. There is more clarity needed on the structure, as well as payouts to distributors, given that now everything is proposed to be under the TER cap,” said Dhirendra Kumar, founder and CEO of Value Research.
“…performance-linked TER can be enabled for active open-ended equity schemes wherein AMCs can charge higher management fees if the performance is more than an indicative return above the tracking difference-adjusted benchmark. Alternatively, AMCs can be permitted to charge a higher management fee based on a pre-decided hurdle rate. Such higher management fees under both models can be either at a fixed rate or on a returns-sharing basis,” says the Sebi consultation paper.
Sebi has recommended two approaches to implement the above.
In the first, only the base expense ratio will be charged during the period the investor remains invested for. At the time of redemption, if returns earned are higher than the hurdle rate/indicative rate, the management fee will be deducted and the balance will be paid to the investor. The maximum fees will be specified as a deterrent to fund managers from taking excessive risks.
In the second approach, a higher expense limit may be fixed and the fund house may charge the TER inclusive of management fees, based on the previous year’s performance of the scheme. In case of underperformance, the base expense ratio will be retained and the balance will be returned to the investor at the time of redemption.
However, this is easier said than done.
“On one hand, there is a proposal to bring in a uniform structure and get rid of the expenses charged over and above the TER. On the other hand, bringing in a structure where there are multiple approaches will only complicate the situation,” says Manmeet Kaur, principal associate, Karanjawala & Co., adding that this will negate the entire idea of bringing in transparency into the TER structure.
The regulator’s proposal is to keep it optional to AMCs to offer such schemes, and also to to test the model under the regulatory sandbox given that this would be a new concept for the Indian MF industry.
Siddharth Shroff, a Mumbai-based MF distributor, said: “Given that larger firms with AUM of above Rs 1 trillion can charge between 1% and 1.3%, it will make more sense to push smaller AMCs that can charge up to 2.55%. Our revenues will take a hit as AMCs cut a percentage of the income before giving us our dues. The regulator should look at uniformity in brokers’ fees as well.”
