IN FOCUS: Key developments in Mutual Funds

At a time when the Indian Mutual Fund (MF) industry is celebrating 25 golden years of existence, we are witnessing important developments in the landscape, some impacted by SEBI while others fuelled by changes in the broader economy. Here’s what you as an investor need to be aware of:

  • Expense reduction in MFs

To pass on the economies of multi-fold scale in MFs to end consumers, SEBI has lowered the Total Expense Ratio (TER) that a fund house can charge investors on Equity MFs, effectively making such investments cheaper at the retail level. TER reduction in MFs will vary by fund size, with larger funds now facing larger cuts in TER than smaller ones.

  • Changes in MF commission model for distributors

In an effort to provide investors with better transparency in MF costs, SEBI has mandated that all MF expenses and commissions must be paid from the MF scheme only. The MF industry is now required to adopt the full trail commission model for all schemes and upfront commissions can longer be paid by fund houses to MF distributors.

Implications: While lower MF fees and new commission mandates might initially hurt distributor margins, the pain will likely be short-lived. Greater transparency for investors combined with lower fees on MF investments will improve demand and increase market size for MF products, thereby contributing directly to top line growth for MF agents. Higher levels of investor participation in the MF industry will ultimately benefit all members of the market ecosystem including investors, financial advisors and mutual fund houses.

  • Panic for Debt MF investors?

The recent weeks have been a stress test for India’s financial system with the future of defaulting behemoth IL&FS on the line. Last week, the Government of India seized the reins of managing the group’s mammoth debt burden, prompting investors to reflect on the implications of “India’s Lehman moment”.

Tremors originating at the epicentre of this crisis have been felt in broader bond markets, as concerns emanate about the strength of NBFC (non-banking financial company) & HFC (housing finance company) balance sheets across the industry. Falling NAVs of associated Debt MFs have drawn warranted scrutiny upon the MF industry with one seemingly alarming statistic: MFs own about 60% of overall NBFC commercial paper issuance. In the face of a weakening rupee coupled with rising bond yields, do MF investors have reason to panic?

The answer is not straightforward. Market experts have attempted to calm investor nerves by asserting that this is more a crisis of confidence, not liquidity, and further adding that the RBI would do the needful to safeguard liquidity in the system. It is noteworthy however that fixed income fund exposure to HFCs (about 12 percent) and NBFCs (about 6 percent) is not, by any means, insignificant. Therefore, at present, it is crucial for those invested in affected debt funds to closely monitor the crisis resolution.

It is now most important for regulators & corporates to collaboratively ensure that similar crises are avoided in the future, by reevaluation of credit rating methodologies, improved due diligence of corporate balance sheets and better diversification in MF portfolios.

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