Ever wondered how the distributor or agent who sells you a mutual fund runs his business? How do you think he makes his living? One might probably assume that the fund companies pay him a certain amount, a commission maybe, for selling their funds. Well, the distributor does get a certain commission, but it doesn’t come from the fund company, he earns it from the investor.
This commission comes in the form of a charge known as load. The distributor has to bear expenses to run his business and a part of it is paid by the investor. The load is also the reason why the investor’s entry price is higher than the fund’s NAV. The difference in the entry price and the NAV is the charge called load.
But how is the load charged, you might ask. Well, there are three different ways. The first way is at the time of entry into the fund. An entry load can be charged by deducting the specified load amount from the initial investment. For example, if Rs 100 is invested in a fund which charges an entry load of 2 per cent, then Rs 2 will be deducted and the actual invested amount would be Rs 98.
The second way of charging load is at the time of redemption. The exit load is deducted from the redemption proceeds of the investor. Hence, if the investment amount has grown to Rs 100 in a fund that charges an exit load of 2 per cent, the investor will get redemption of Rs 98. The third way of charging load is dependent of the duration of stay in the fund. For example, if the units are redeemed before six months, the fund charges an exit load of 0.5 per cent. This figure of course changes with different time periods. This time-based exit load is called Contingent Deferred Sales Charge (CDSC).
Most equity funds charge an entry load and no exit load. Loads are generally higher in actively managed equity schemes than in passively managed ones. On an average, an actively managed equity fund charges an entry load of 2 per cent, while the average index fund charges an entry load of 1 per cent.
On the other hand, debt funds do not levy an entry or exit load. However, most of them do charge a CDSC. Most medium and long-term debt and gilt funds levy a CDSC of 0.5 per cent if redemption occurs within six months of investment. For short-term debt funds, the period of the CDSC reduces to a maximum of 30 days and the quantum of load falls to 0.25 per cent. Generally, in debt funds the quantum of the CDSC and its duration decreases as the investment horizon of the fund decreases.
Mutual funds are allowed to charge a maximum load of 6 per cent, and in the initial days, equity funds did charge such a high amount of load. However, the competition has now increased with a wide gamut of funds available for investors to choose from and hence, the days of high loads have gone by.
The load can be looked upon positively as well. Load helps in imparting discipline to investing. The CDSC of 0.5 per cent in debt funds exists to ensure that an investor stays in the fund for more than six months. This benefits the investors too as the minimum holding period for these funds should ideally be one year and more.
So, is the load something that an investor has to pay no matter what? Not really. As per a recent ruling from market regulator SEBI, fund companies cannot charge a load when the investor invests with them directly. This means that if an investor buys units of a fund directly from the fund company, and not through a distributor or agent, there would be no load charged and the entire amount would be invested.