When you invest in an equity fund, you must have noticed that your entry price is higher than the NAV of the fund. When you invest in a debt fund, the entry price is the same as NAV. Why is it so? Well the reason for the difference between the entry price and the NAV is due to a charge called load. This load is not a weighty matter, but is something very simple.
The distributor who sells you a fund has to bear expenses towards running his business. A part of this cost is borne by investors in the form of load. A load is thus the charge that an investor pays for the recovery of these expenses.
Load can be charged in three different ways. First, at the time of the entry into the fund, by deducting the specified load amount from the initial investment. Such a load is called an entry load. For example, if Rs 100 is invested in a fund which charges an entry load of 2 per cent, Rs 2 will be deducted and Rs 98 will be the amount actually invested. Load can also be charged at the time of redemption - called exit load. In this case the load amount is deducted from the redemption proceeds of the investor. For instance, if the investment has grown to Rs 100 in a fund that charges exit load of 2 per cent, he will get redemption of Rs 98 (100-2). Another way of looking at the load is that in the NAV will increase proportionally when entry load is charged and will fall proportionally when an exit load is levied. A third type of load is similar to the exit load. Here the load is charged depending on the duration of stay in the fund. Thus for example, if units are redeemed before six months an exit load of 0.5 per cent is levied. This time-based exit load is called contingent deferred sales charge (CDSC).
Most equity funds tend to charge an entry load and no exit load. Most of the equity schemes of UTI Mutual Fund, however, charge an exit load. But they do not levy any entry load. Across the category of equity schemes, loads are greater in actively managed equity schemes than in passively managed ones. Thus the average actively managed equity fund charges an entry load of 2 per cent. The average index fund, on the other hand charges an entry load of 1 per cent.
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. Cash funds do not charge any load or CDSC for that matter. Generally in debt funds the quantum of the CDSC and its duration decreases as the investment horizon of the fund decreases.
Regulations allow a fund to charge a maximum load of 6 per cent. In the initial days of the fund industry, this actually used to happen in case of equity funds. One can also feel happy with the load charged by equity schemes in India. In the US the average equity fund charges an entry load of 6 per cent. Another way of looking at it is that a load imparts discipline to investing. The CDSC of 0.5 per cent in debt funds exists to ensure that you stay in the fund for more than six months. It is in your benefit too as the minimum holding period for these funds is ideally one year and more.
While the load is an expense you have to bear to participate in a mutual fund, it is not the only expense that you pay for the pleasure of investing in a mutual fund. The expense ratio is the sum of all charges that you bear to invest in a fund. This is in addition to the load. So along with the load, do check the expense ratio of the fund you invest in too.