Less Expensive

Sebi has decided to scrap initial issue expenses for close-ended mutual funds

The Chairman of the Securities and Exchange Board of India (SEBI), M Damodaran, saw the completion of his tenure in February 2008. But before he said goodbye, he ensured that mutual fund investors would remember him fondly. Though the distributor community would certainly not.

Early January, 2008, SEBI waived off the entry load for mutual fund investors who invest directly in schemes from fund houses. Investors now have the option of bypassing the distributors and not paying any entry load. This was certainly bad news for fund distributors.

By the end of January, market regulator SEBI decided to scrap the initial issue expenses for close-ended funds. SEBI chairman, M Damodaran, explained the move as one that will “make close-ended mutual fund schemes less expensive for retail investors”.

Way back in April 2006, SEBI had prohibited mutual fund houses from charging and amortising issue expenses on open-ended schemes. This move was particularly beneficial to the long term investor in an open-ended fund, who would have to bear the cost of earlier redemptions by other unit holders. But the regulation was not of much help as fund houses rushed to launch close-ended schemes. That's because the same ruling stated that fund houses could continue to charge and amortise the initial issue expenses of the close-ended schemes for the entire period they remained closed - up to three years. But they could not charge an entry load like the open ended schemes.

After that, fund houses switched to launching more close-ended schemes. The mutual fund houses were allowed to amortise issue expenses of up to 6 per cent of the amount collected when a new scheme was launched. So if a scheme raised Rs 1,000 crore it was allowed to recover up to Rs 60 crore as initial issue expenses from the investors investing in the scheme. These expenses would include all costs related to sales, marketing, advertising, printing, mailing and commissions paid to agents and brokers. In other words, expenses that had to be incurred in order to make an investor aware of a scheme and get him to invest in it.

Distributors not only got commissions from the entry load but also from the initial issue expenses. Many distributors would pass on part of this commission as kickback to high networth investors who would put in big amounts in a new fund offering (NFO). Now that mutual funds cannot charge the investor for initial issue expenses, there is no way it can pay its distributors such high commissions.

Fund houses will still launch closed-ended schemes, if the nature of the scheme warrants such a structure. But no longer will it be a monetary move. As they are no longer in a position to pass on the initial issue expenses to the investors, there remains very little incentive for them to launch such schemes.

(by value research)