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Suresh Krishnamurthy

SEBI's ruling that service tax of 5 per cent payable on management fees cannot be charged against the various schemes, over and above its prescribed limits applicable for various schemes, is welcome. However, SEBI has said that it is an allowable item of expenditure under the existing limits. This means costs charged to the scheme may go up, though the rise may be marginal.

Pressure piling up: This is not the first time that the Association of Mutual Funds in India (AMFI) has made a representation to SEBI regarding costs. Earlier, a request to enhance the limits regarding charging of costs annually was disallowed by SEBI. SEBI, on its part, allowed further flexibility to mutual funds to charge any expenses directly attributable to the scheme in November 2000.

These instances suggest that the asset management companies are piling up pressure on SEBI for relaxation in the amount of costs charged to the various schemes. The motivation on their part comes from their poor financial performance. Some funds have existed for more than five years and are still in red.

However, SEBI cannot consider the financial performance alone while deciding on the issue of costs charged to the schemes. The intense competition in the industry (which has more than 15 players) and also the reluctance of Indian investors to take to investing through mutual funds may be playing a bigger part. Costs, however, need to be viewed from a long-term perspective. Short-term exigencies cannot dictate long-term policy. As such, SEBI should not succumb to the pressure to enhance the limits on costs. In this context, it has to be said that SEBI has been holding up well and needs to be applauded for their stance.

In addition, even in future, SEBI should make changes to the load structure and not the costs charged. If asset management companies feel that they cannot operate under this framework, they can charge entry loads. Loads are more transparent, levied up front and allows for comparison between various schemes. Adverse effects: Any relaxation of the guidelines on charging costs has the potential to adversely affect investors in mutual funds. In the case of debt and monthly income schemes, lower costs can make a positive contribution because the expected returns are now lower at 10 per cent or below. Rising costs can only make things worse.

Mutual funds can already charge up to 2 per cent of the net assets as costs. In the case of debt funds, most asset management companies do not charge up to the maximum allowed limits. The expenses charged range from between 1.25 to 1.75 per cent. That is still substantial given the expected returns from an investment in debt funds. So, any relaxation can potentially make investors shun mutual funds and invest on their own.

US state of affairs: Normally, comparisons are made with the US regarding most issues since our mutual fund industry has been modelled on the US framework. In the case of costs, it is pertinent to note that costs charged to debt schemes are much below what is charged in India. Costs charged are in some cases less than 0.50 per cent.

Yes, the sizes of the smaller schemes in the US are several times bigger than the biggest schemes in India. So, we cannot expect costs charged to be similar to what is happening abroad. Having said that, the costs funds can charge need not be entirely out of line with what is the case in the US. As such, the framework appears best suited to the interests of both investors and asset management companies.

Differential loads: There may be a case for allowing funds to charge higher loads in the case of equity schemes. In the US, equity schemes can charge up to 8 per cent of the initial investment as entry load. However, in India, higher loads may not be in the interest of asset management companies themselves. Higher entry loads can ensure that investors shun mutual funds and start direct investing on their own.

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