One of the structures that Sebi is considering is to have a Base Total Expense Ratio (TER) and then allow mutual funds to charge performance fees over and above this. TER is the overall fee that mutual funds charge investors every year.
The thinking at Sebi is that the Base Total Expense Ratio for a scheme could be “half of the actual TER limit or actual cost excluding management fee, whichever is lower,” according to a person familiar with the plan. So, if a scheme is charging a Total Expense Ratio of 2.25% – the highest fee that an equity scheme can collect from investors – the mutual fund, under this proposed structure, would be permitted to charge 1.125% as base TER.
Depending on the scheme’s ability to beat the benchmark, the fund could be allowed to charge up to 1.5 times the Base Total Expense Ratio as performance incentive, said the person cited above. So, if an equity scheme’s base TER is 1.125% and it charges a performance fee of 1.5 times base TER on superior returns, the total fee that the fund can charge the investor is about 1.7%. The fund, however, can charge investors a performance incentive only on redemption from the scheme.
Another option that Sebi is considering is to allow mutual funds to charge the normal Total Expense Ratio. So, if the TER chargeable by the equity scheme is 2.25%, the fund house would collect this entire fee. Here too, the performance fee can be charged only on redemption. When the investor pulls money out of the scheme, the fee will be calculated based on the product performance. If the scheme has outperformed the benchmark, the fund can retain the fee. In the event of underperformance, the fee collected by the fund must be repaid to the extent of the returns at the time of redemption.
The underlying factor in both these options is that the performance fee can be finalised and charged only on redemption by investors.
The regulator is in the process of putting together a discussion paper on this matter that will seek the feedback of the industry and other market participants.Sebi didn’t respond to queries.
The proposal to introduce a performance fee structure for the first time in India comes in the wake of Sebi’s plan to overhaul the Total Expense Ratio structure aimed at reducing the cost of investing in mutual funds.
Last week, a top Sebi official said at a mutual fund summit that a working group has been set up to see if performance fees can be introduced for the industry. Since then, the industry has been abuzz with speculation on the likely structures of such performance-driven incentives.
Contrary to expectations, mutual funds are unlikely to get the freedom that AIFs and PMS – products mostly used by the more affluent investors – get to set performance fees, said sources. In AIFs and PMS, there is a lot more freedom for asset managers to charge profit-sharing fees if they generate superior returns.
Most mutual fund managers must raise their game to be eligible to charge performance fees. Several equity schemes – especially those focused on large-caps – have been underperforming their benchmarks in recent years. Mutual fund industry officials said Sebi must consider easing benchmark returns calculations to help schemes outperform more often.
