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Revised 'Total Expense Ratio' of mutual fund schemes

Finsec Law Advisors

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Pursuant to its board meeting on September 18, 2018, SEBI has issued a press release announcing the following decisions taken with respect to the mutual fund industry:

Change in TER slabs

The Total Expense Ratio (“TER”) slabs, i.e. the amount of fees that can be charged by a scheme, are based on the total assets under management (“AUM”) of the scheme. To put it simply, the higher the AUM of a scheme, the lower the TER. These slabs were introduced in 1996, and remained unchanged since then. As the AUM of the industry grew exponentially over the past few years, a need was felt to pass on the benefits of economies of scale to the investors. To this effect, SEBI has decided to lower the costs to investors by introducing more slabs and reducing the TER in each slab. Further, TER for close ended schemes, index schemes, ETFs, and Fund of Funds has also been reduced.

Prohibition on upfronting commission

SEBI has now mandated that all commissions and expenses shall be paid out of the scheme and not from the AMC/Associate/Sponsor/Trustee. Further, the upfront commission model has been junked and the industry must only pay commission on a full-trail model. Currently, two types of commission exist – upfront commission and trail commission. Upfront commission is commission paid to a distributor at the time of purchase of new investments, while trail commission is commission received by the distributors every year until the investment is withdrawn. Prohibiting upfront commission would restrict churning, as the distributors would now not have an incentive to advice investors to change their schemes to take benefit of upfront commission.

Ceiling on TER for close-ended schemes

As discussed above, TER is based on AUM slabs. Being small-sized funds, the close-ended funds allowed fund houses to charge a higher TER. Distributors were also given excessive upfront commission, which led to mis-selling of the products. This is a cause of concern as investors were being overcharged, especially since it has been observed that the performance of close-ended schemes is similar to that of open-ended schemes.

To counter this mis-selling and protect investors, SEBI has now fixed the maximum TER chargeable for close-ended equity-oriented schemes at 1.25% and for other close-ended schemes at 1%. Further, as discussed above, it has directed fund houses to adopt a full trail model of commission payment, without payment of any upfront commission or upfronting of the trail commission.

Disclosure: Mr. Sandeep Parekh of Finsec is a member of the MFAC.