SEBI Proposes Drastic Overhaul of Mutual Fund Expense Structure, Introduces Performance-Linked TER

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The Securities and Exchange Board of India (SEBI), the country’s capital markets regulator, has put forth a comprehensive proposal for significant changes in the way mutual funds charge their expenses to customers. The move aims to simplify and tighten the definition of the total expense ratio (TER) by including all additional expenses that fund houses were allowed to charge beyond the TER.

Currently, equity funds can charge investors a maximum TER of 2 percent for the initial Rs 250 crore invested, with decreasing costs for higher amounts. However, fund houses are also permitted to charge brokerage and transaction costs of up to 0.12 percent of the trade value, which SEBI found were often higher than the TER itself, leading to double charging for investors. In its proposal, SEBI suggests that certain expenses previously charged to investors should now be borne by the investor education fund, including brokerage costs related to research reports purchased by fund houses. Additionally, SEBI recommends that the commission paid to distributors for soliciting clients from beyond the top 30 towns should be funded by the investor education fund. The regulator also proposes incentivizing distributors to attract more women investors, with the associated commission also covered by the fund.

Furthermore, SEBI’s proposal includes the introduction of a performance-linked TER, which would charge management fees at the time of redemption based on the fund’s performance relative to benchmark indices or a pre-determined hurdle rate. This aims to address concerns about fund managers receiving fees regardless of the scheme’s performance. Alternatively, the regulator suggests charging a TER throughout the investment tenure and refunding the management fee if the fund underperforms at the time of redemption. SEBI also aims to standardize expense ratios across fund houses by introducing category-wise structures for equity, debt, and hybrid schemes. This will prevent variations in expense ratios for different schemes and discourage customer churn caused by varying commission rates. The new formula will result in lower TER for larger fund houses. Overall, SEBI’s proposed changes seek to enhance transparency, protect investor interests, and promote fair practices within the mutual fund industry.

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