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Carrot and Stick Policy

Lures and warnings may be used by funds to retain investors’ money

With the market regulator, the Securities and Exchange Board of India (SEBI), recently announcing changes in the load structure of equity funds, entry loads were abolished, the entire sector might well unleash a different trend in the days to come.

The exact steps to be taken by MF industry after the new SEBI rule abolishing entry loads are still unclear, but figuring from the present situation, there are some current practices and conventions that may point to the future course of action to be adopted by the industry.

The first thing that fund houses are likely to do is to take a re-look at exit loads. These are rules that fund houses have implemented over the years to prevent early exits or redemptions by investors. Funds want to ensure they retain investors’ funds over the long period and the feature that allows them to do so is the exit load structure on their equity funds – retail investors’ investment in debt and liquid funds is negligible, so these can be ignored for our purpose.

At the moment, investors are charged prohibitive rates if they look to exit early from their investments.

Under the present guidelines, the total of entry and exit load as a percentage of the applicable net asset value (NAV) can be a maximum of 7 per cent. But this high figure has never actually been implemented. Currently, the equity funds generally charge an entry load of 2.25 per cent, the maximum being 3 per cent under the equity funds of Fidelity Mutual Fund. The exit loads usually vary from zero to 4 per cent.

However, now, since there is no entry load, and funds are unlikely to pay money out of their own pockets to distributors for selling their products, money managers may have a good enough reason to revise their load structure all the way up to 7 per cent and look to pay distributors out of gains accruing thereof. In other words, if MFs want to reward distributors for selling their products, they will look to make the most out of the investments already made with them.

This, experts feel, can also be a source of investor education, as it will point out the profit potential of long-term investing and discourage people from opting for early redemptions in situations like the one seen over the last two months when the markets rallied to unpredicted highs – Sensex alone gained by 90 per cent from March 9 to Jun 11. Seeing their investments reaching great heights, after the surge in the markets, the once-scalded-by-market investors decided to redeem their investments -- take their money and run before the markets tank again.

Here are some instances of funds houses which have already started setting up systems in place that prevent or discourage people from redeeming their investments too early.

ING Mutual Fund, Tata Mutual Fund, ICICI Prudential MF and Kotak Mutual Fund are among the funds that have hiked the exit loads for their equity schemes.

Tata MF has recently revised the exit load under its index funds at the highest in any equity scheme, which is now set at 4 per cent for redemptions within 90 days.

Kotak Mutual Fund has increased the exit load under five of its equity schemes to 2 per cent for redemptions within 2 years while ING Mutual Fund has increased the first slab (up to Rs 2 crore) for which it charges higher exit load under 2 of its schemes.

ICICI Prudential MF had increased the exit load applicable under all its equity schemes at the beginning of this month itself.

For example, earlier, under ICICI Pru Discovery Fund and ICICI Pru Dynamic Fund, an exit load of 1 per cent was being charged on redemptions happening within the first 6 months and 0.50 per cent for redemptions happening between 6 months to 1 year. This has now been uniformly applied at 1 per cent for any redemption within 1 year.

Sundaram BNP Paribas MF has gone the other way and is charging an exit load of 1 per cent for redemptions within 1 year on investments of under Rs 1 crore. For sums over this amount, the load is applicable only for 6 months. Earlier, the first slab was extended up to Rs 2 crore. The change in effect means that amounts greater than Rs 1 crore will now be subject to load during the first 6 months only.

These practices by MFs tend to punish those who take out their money after a short period, and at the same time take away investors’ freedom to do what they want with their funds and, in an emergency situation, it can put investors in a quandary, forcing them to book losses just to withdraw their money from a fund. Alongside dealing with the prohibitively high exit loads, what will be required of investors is to make informed decisions on their initial investments and not just going with the trend.

As the MF industry races to re-organise itself after the new SEBI rule was announced, it remains to be seen whether these old steps will become a rage in this space or remain just a passing fancy, to be overtaken ultimately, by an entirely different formulation.