SEBI proposes changes in mutual funds’ Total Expense Ratio to curb mis-selling

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SEBI’s proposed sweeping changes to mutual funds’ Total Expense Ratio (TER) will curb distributor practices of unnecessary switching of schemes and pushing new fund offerings for higher commissions, experts said on Friday.

TER accounts for the fees and expenses charged by asset management companies (AMCs).

The Securities and Exchange Board of India (SEBI), in its consultation paper on Thursday, proposed the introduction of performance fees for funds.

It proposed two approaches in this regard but also suggested testing the models under the Regulatory Sandbox.

Considering the underperformance of most mutual fund schemes, the proposal to introduce performance-linked expense ratios along the lines of Portfolio Management Services (PMS) is a step in the right direction, Gopal Kavalireddi, Head of Research at FYERS, said.

Globally, many markets have performance fee structures, but the prevalence of these is limited. Many times, performance fee structures tend to be too complex for investors to understand, Kaustubh Belapurkar, Director – Manager Research at Morningstar India, said.

In addition, the regulator has suggested that TER should be levied at the AMC level and not at the scheme level at present. Moreover, slabs should be bifurcated as equity and non-equity-based assets under management (AUM).

Under the proposed framework, SEBI has suggested that at the AMC level, the maximum TER that can be charged for an equity scheme is 2.55%. This limit should be for AMCs that fall within the first AUM slab (up to ₹2,500 crore).

Further, SEBI is looking to bring all additional heads of expenses under the overall TER. It means all transaction charges should be a subset of the TER itself.

It has been proposed that brokerage and transaction fees should be included under this limit alongside securities transaction tax (STT).

The move would help investors have full transparency on the total costs of making investments, Morningstar India’s Belapurkar said.

At present, SEBI allows AMCs to charge four supplementary types of expenses beyond the specified TER limits. These include brokerage fees, transaction costs, distribution commission for inflows from B-30 cities, goods and services taxes (GST), as well as exit load-related charges.

While these proposals would impact the distributor commissions and earnings of AMCs, they will help retail investors and promote financial awareness and inclusion, FYERS’ Kavalireddi said.

In addition, the regulator has suggested that AMCs should be allowed limited membership in the stock exchanges for executing trades for their own mutual fund schemes.

The proposal regarding fees and expenses charged by AMCs to unitholders of mutual fund schemes would facilitate greater transparency in the 42-player mutual fund industry and accrual of benefits of economies of scale to investors.