Virtues of Spending Less

Now that the returns generated by debt funds are on a decline, fund expenses are also coming under pressure. When a fund was providing a return of 15 or 20 per cent, losing 1.75 or 2 per cent of that did not matter. But as yields threaten to drop to the 7-9 per cent range, losing up to a fifth of gains by way of fund expenses is more than what investors can bear.

Sure enough, an increasing number of debt funds are responding to these worries by slashing expenses. Expenses that investors pay directly such as those that are deductible from the net asset value include management fee, marketing and selling expenses, registrar fees, custodial fees, cost of investor communication, as well as distributor's commissions. And as every savvy investor knows, that distributors' fees includes the now-illegal passbacks — or incentives as they are more commonly known — that are paid to investors. But, with Securities and Exchange Board of India (SEBI) disallowing this practice, the investors are at a loss because they used to add this incentive to their total return.

Passbacks apart, many fund houses have already slashed the commissions they pay to their distributors. For instance, Reliance Mutual now pays just 0.05 per cent commission for its Cash Plan and DSP Merrill Lynch has reduced commissions from 0.4 per cent to 0.25 per cent for its short term debt fund.

Expenses are beginning to head south too. Franklin Templeton Mutual has lowered the expense ratio in Templeton India Treasury Management from 1 per cent to 0.75 per cent and Templeton India Short Term Income from 1.2 per cent to 0.9.

The one change that will impact many investors directly is the outlawing of passbacks. Sure, this will reduce expenses, but since this is something that affects the funds and the distributors' sales strategies, investors will probably have to be shown in unambiguous terms that the benefits they used to get as incentives are still coming through to them as lower expenses.

Franklin Templeton is the first asset management company to try and do this systematically with a new Institutional Plan under its Income Builder Account. This scheme will have a low expense ratio of 1 per cent as against the existing plan's expense ratio of 1.72 per cent but is open only to corporates and institutional investors and has a minimum ticket size of Rs 1 crore.

How will this boost the fund's returns? Says Nilesh Shah, chief investment officer-fixed Income, Franklin Templeton, "Our investors will be big gainers from our reduced expenses. You can expect an additional half a per cent boost to the net asset value over a year." That should certainly cheer up investors.

"This will certainly benefit my customers and make my life easier. Some of what large investors lost in passbacks will now come back to them in low-expense funds like this one," says Sandeep Parwal, managing director, SPA Capital.

A direct comparison between a low-expense and a higher-expense fund is possible with a fund from Kotak Mutual. Its interesting to compare two plans of Kotak Mutual's bond fund — K Bond Wholesale and K Bond Deposit Plan. The two schemes have substantially similar portfolios, but the Wholesale plan's expense ratio is much lower by 0.55 per cent. This clearly plays a role in its returns, which are 0.7 per cent higher than K Bond Deposit Plan.

While this is probably the beginning of a trend, it seems evident that it will continue. With debt fund yields set to remain low, the Indian investor's increasing expense-consciousness and SEBI's crackdown on passing back of distributor commissions is bound to change the way funds are run and sold.