The investment landscape in India subject to regulatory updates, and the latest proposals by the market watchdog SEBI (Securities and Exchange Board of India) have drawn particular attention amongst mutual fund (MF) investors. SEBI has released a consultation paper proposing a full review and rewrite of the SEBI (Mutual Funds) Regulations, 1996. India’s mutual fund industry has grown rapidly and over nearly three decades, multiple amendments have made the rules quite detailed. SEBI’s goal is to simplify the language, remove outdated provisions, and make the regulations easier to understand and apply for all stakeholders.
The proposed overhaul may change how MFs charge investors and disclose costs, with an aim to simplify fee structures and enhance transparency. Here is what the new proposed rules entail, what may change, and what it could mean for you as an investor.
The mutual funds landscape
Investing in mutual funds is one of the most accessible and popular ways to build long-term wealth. But, like any financial product, it comes with certain costs that investors should be aware of. These charges—though sometimes small—can have an impact on your overall returns. For new investors, the range of fees and terms associated with mutual funds can seem confusing at first, making it all the more important to understand what you’re paying for and why.
So what are some of the costs defined by SEBI that investors may incur when investing in mutual funds?
- Total Expense Ratio or TER: This is the total annual cost charged by a mutual fund to its investors, expressed as a percentage of the fund’s assets (AUM). It includes management fees, administrative expenses, marketing/distribution, etc.
- Expense Ratio: This is often used interchangeably with TER, especially by investors. It is essentially the same concept, the cost to the fund and investors of running the scheme.
- Securities Transaction Tax or STT: This is a tax levied on transactions in securities like stocks and derivatives in India. When a mutual fund makes trades, it may incur STT.
- Goods and Services Tax or GST: This is the tax on consumption of goods and services. Some services used by asset-management companies (AMCs) may attract GST which becomes part of the total cost.
Another term to note is basis points or bps: a common unit that is used to measure small changes in percentages especially in relation to interest rates, returns, or fees, like the TER of a mutual fund.
The proposed new rules
Investors are charged a fee called expense ratio to pay for the mutual fund’s operating expenses, which is deducted from net asset value (NAV) of the fund. A reduction in fees will mean less money deducted under the expense ratio umbrella, freeing up assets for the investor.
- Overall cost and fees: Various cost components like brokerage, taxes, should be excluded from the TER/expense ratio, or at least shown separately, so investors see clearly what’s being charged.
- Proposed caps on brokerage fees: SEBI has proposed limiting just how much MFs can pay brokers when they buy or sell investments. For cash market trades, the cap could drop to 2 bps/basis from the current 12 bps; for derivatives trades the cap might drop to as low as 1 bps from 5 bps.
- Cost breakdown and scale: MFs may now be required to present a clearer breakdown of their expenses, detailing how much is spent on management, trading, taxes, and other operational costs. They will also need to explain how they plan to pass on the benefits of scale as their assets grow.
- Performance-linked fee: SEBI has also proposed an optional performance-linked TER, where funds could charge higher costs if they deliver better results and outperform against the benchmark, though this is still under consultation.
What this means for investors
While this move may hit revenue for brokerages in the short term, it has benefits for investors.
- Lower cost, slightly better returns: If costs go down (or are more transparent), then more of the fund’s return accrues to investors. For example, if a fund’s TER drops from 1.50% to 1.20%, investors keep an extra 0.30% of the investment’s return (all else constant).
- Better transparency: Investors will hopefully now be in a position to better understand what they are paying for (for example, management fees vs brokerage fees vs taxes). Funds may have to list out major cost components instead of placing them under the larger TER/expense ratio umbrella. This makes comparing funds and selecting the right one easier.
- Scale effect benefits: Larger funds might reduce their TERs because they must under rules; smaller funds might also face pressure to reduce costs or justify them. So investors can pick a fund that comes with scale and a lower cost. The idea that as Assets Under Management (AUM) grow, cost-loads should come down, means larger funds should be able to spread fixed costs over a bigger base and thus reduce cost per investor.
By overhauling the mutual fund fee structure, SEBI aims to enhance transparency and make it easier for retail investors to understand the costs involved. By limiting brokerage charges, mandating greater cost transparency, and ensuring that the benefits of scale are shared, SEBI is making it clear that investors should bear a lower overall cost.
Over time, SEBI’s new mutual fund rules could benefit both investors and fund houses. Investors stand to gain from fairer fees, clearer cost breakdowns, and potentially better returns. For MFs and AMCs, these new rules may encourage efficiency and greater transparency. If carried out well, these changes could create a healthier, more trusted mutual fund industry in the long run.
Sources
SEBI’s New Mutual Fund Rule May Change How You Invest
Indian asset managers fall on potential profit hit from regulator’s fee structure changes | Reuters
India markets regulator proposes measures to simplify mutual fund fee structures | Reuters
SEBI’s new mutual fund fee proposal: What it means for investors – CNBC TV18
Proposed brokerage fee cap may be the biggest jolt for mutual funds in Sebi’s regulatory overhaul