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Boy That Hurts!

It's possible that you ignored the latest SEBI regulation, allowing AMCs to charge 5% service tax on management fees to MF schemes. Do you know that this norm could make your fund more expensive?

Oh no! That's probably gonna be your reaction if you hear what we are about to tell you. Already with the yield universe shrinking, this is a blow that will throw you off-gear. The market regulator, SEBI, has allowed asset management companies (AMCs) to charge the 5% service tax on management fees to the mutual fund schemes. To put it simply, an AMC can charge service tax to the schemes as an item of general expenditure.

Starting this fiscal, AMCs -- which invest and manage the schemes on behalf of a mutual fund – have been slapped with a 5% service tax on their income, which an AMC earns as management and investment advisory fees, capped at 1.25% of the average weekly net assets. However, this percentage varies according to the fund's objective. For an equity fund, it hovers in the range 1-1.25% and for debt funds it varies from 0.75-1%. In the case of cash funds though, the fee is minimal -- 0.35-0.75%.

So, what does it mean for an investor?
A 5% service tax would mean a proportionate rise in the investment and management fees. For instance, for an equity fund now the management fee will be in the range of 1.05-1.30% and for a bond fund, it would be 0.80-1.05%. A cash fund will have to dish out a fee of 0.40-0.80%. These expenses form a part of the total recurring expenses for a mutual fund, which also include administrative expenses, distribution, selling cost, etc. While calculating the NAV, these recurring expenses are deducted on a daily basis. In a nutshell this means that investors will have to pay a price in the form of reduced returns.

How Expensive The Giants Will Be
  Management fee*     Recurring exp*     
  Currently  Post-service tax  (incl. mgmt fee)
Debt Funds
Pru ICICI Income Plan 1.00 1.05 1.60  
HDFC Income Fund 1.01 1.06 1.67  
Birla Income Plus 1.00 1.05 1.65  
Templeton India Income 0.99 1.04 1.59  
Equity-Diversified Funds
Alliance Equity 1.07 1.12 2.32  
Birla Advantage 1.07 1.12 2.2  
Pru ICICI Growth Plan 1.08 1.13 2.33  
Pioneer ITI Bluechip 1.09 1.14 2.35  
Cash Funds**
Pru ICICI Liquid Plan 0.70 0.75 0.99  
HDFC Liquid 0.59 0.64 1.00  
Birla Cash Plus 0.65 0.70 1.18
Templeton India Liquid 0.50 0.55 0.99
"*%age of weekly average net assets as on March 31, 2002"
"**Data for the largest cash fund, Reliance Liquid Treasury Plan, is not available"
If we look at equity funds as a whole, investors won't be impacted much considering the fact that returns accruing from this category is usually on the higher side, hence, the impact will be marginal. The sole exception in this category though will be index funds, which will take a hit. That's because these funds track the chosen benchmark index and strive to perform in line with it, and, therefore, expenses are generally low here.

However, the biggest losers will bond funds, where realistic returns are in the 8-9% range per annum, and a higher expense outflow can mar their returns. For example, K-Bond Wholesale and Deposit Plan. Despite a similar portfolio and asset base, K-Bond Wholesale Plan, with annual recurring expenses 55 bps lower than Deposit Plan, has clocked superior performance across time periods. The situation may be worse in the case of a cash fund, where returns are just marginal, about 6-7% per annum. So, here, even 5 basis points would make a huge difference.

While doing this SEBI has also stipulated that the current prescribed maximum cap of 2.25% of weekly average net assets under no circumstances should be exceeded. Therefore, after doling out higher management expense, a fund will be really toiling hard to keep its annual expenses within the prescribed limit. So, dear investor, do look out for the fund's expenses before falling for its bait.