Small MFs to suffer post expense-ratio cuts as it becomes a scale gameSmall mutual funds, the Davids of the Rs 25 lakh crore-AUM industry, may be losing to Goliaths soon. Yes, thanks to the SEBI’s MF cost-cutting initiatives, the schemes with smaller asset sizes are expected to get less attention from AMCs and distributor fraternity. The reason is simple: there is a major reduction in expenses for equity schemes with an AUM less than Rs 500 crore.

Fund houses are still evaluating the impact the move will have on the existing trail and up-fronting of trail commissions being paid to distributors. Going ahead, investors will benefit with marginally higher returns, given the reduction in costs.

On September 18, 2018, the Securities and Exchange Board of India or SEBI in its board meeting decided to reduce the Total Expense Ratio (TER) charged by mutual funds. Simply put, TER is a management fee charged by a fund house as a percentage of the assets managed by a scheme. The regulator has not only cut the expense ratio in the top AUM slab but also restructured the AUM slabs considering the economies of scale.

There is a major reduction in expenses for equity schemes with an AUM less than Rs 500 crore. In the schemes with smaller size, SEBI has reduced the expenses from 2.50% to 2.25%.

For an AUM between Rs 500 crore to Rs 2000 crore, there is an insignificant difference. The TER gradually reduces from 2.25% to 1.90% under both the old and new TER criteria for equity funds.

TER For Equity Funds

TER For Equity Funds
AUM (Rs Cr) OldTER NewTER Difference
100 2.50% 2.25% -0.25%
500 2.25% 2.25% 0.00%
1,000 2.05% 2.06% 0.01%
2,000 1.90% 1.91% 0.01%
3,000 1.85% 1.80% -0.05%
5,000 1.81% 1.72% -0.09%
10,000 1.78% 1.61% -0.17%
20,000 1.77% 1.52% -0.25%
30,000 1.76% 1.45% -0.31%
40,000 1.76% 1.40% -0.36%
50,000 1.76% 1.34% -0.41%
(Source: PL Research)

As the assets grow beyond Rs 2,000 crore the difference in the TERs widen. From a difference of just one basis point (bps) at Rs 2,000 crore, the gap between the New TER and Old TER widens to 17 bps at Rs 10,000 crore. As the assets grow to Rs 20,000 crore, the difference widens to 25 bps and as much as 30 bps for schemes with an AUM of Rs 30,000 crore. But how many schemes really are that big?

AUM and scheme sizes

AUM (Rs Cr) No. Of Schemes As a percentage of total no. of schemes
0-500 112 38%
500-1000 45 15%
1000-2000 38 13%
2000-5000 50 17%
5000-10000 28 9%
10000-20000 13 4%
Greater than 20000 10 3%
Total 296 100%
(Source: PL Research)

As per Prabhudas Lilladher MF Desk, there are about 296 open-ended equity-oriented funds. Of these, about 112 schemes or 38% of the schemes have an AUM under Rs 500 crore. Investors in such funds will see a sharp reduction in TER of their schemes.

About 83 schemes have an AUM of Rs 500 crore to Rs 2000 crore. These schemes will not be too impacted by the new TER rules.

About 78 schemes have an AUM between Rs 2000 crore to Rs 10,000 crore. Such schemes will see a marginal reduction in TER. The reduction in TER may go up to a maximum of 10 bps.

Just 23 schemes have an AUM over Rs 10,000 crore. Investors in these schemes will benefit from a reduction in TER.

About 119 schemes or 40% of the schemes may see a reduction of over 10 bps in the expense ratio. Of which 56 schemes may have to reduce their expense ratio by over 20 bps.

Thus, if you are investing in equity schemes with a large AUM, you stand to benefit from a lower expense ratio.

Also, as TER is on the declining trend it will impact the commission payout structure to mutual fund distributors.

More and more fund houses will adopt trail-based commission payment to distributors while abolishing upfront commission on investments (with few exceptions like SIP).

This means that intermediaries would attempt to have a long-lasting relationship with investors in order to have a continuous flow of trail commission. Therefore, as an investor, you stand the chance of getting better service and advice by your distributors or other intermediaries, according to Navin Chandani, Chief Business Development Officer, BankBazaar.

Staff Writer

This article is written by RupeeIQ editorial staff.