Fixed-income investors have been grappling with falling interest rates for quite some time. Although returns have nosedived across debt-fund categories, expense ratios have remained flat over the last one year. It has resulted in expenses starting to eat away a much bigger chunk of returns. As depicted in the graph titled 'Declining returns-expenses spread', the spread between returns and expenses has evaporated rapidly.
For the regular plans of funds in some categories, expenses now account for as much as 20 per cent or more of the returns (post expenses). That is a big blow to investors who are already desperate for yields. The graph titled 'Eating out returns' sheds light on this. Undoubtedly, it is not a pretty sight for any fixed-income investor.
The way forward
Well, there is little to do when it comes to the return side of the equation. Interest rates are low and may remain so for a while, owing to the ongoing pandemic. So, you should moderate your expectations there.
And when it comes to expenses, we would love to see AMCs proactively reducing them a bit to cushion the impact of falling returns (how about some 'swing' factor on expenses too?). That may be too much to expect!
But investors can at least switch to direct plans to reduce their expense outgo. For internet-savvy investors who can manage their investments on their own and transact online, the shift from the regular to the direct plan will have a considerable effect on the returns they earn. Of course, expenses as a percentage of returns have increased in direct plans as well but the figures don't seem onerous here (see the graph 'Better cushion still').
While there are categories such as liquid funds where a majority of money is already parked in direct plans, there are others like short-duration funds where a big portion of their AUM is still invested in regular plans. These investors can benefit meaningfully by switching from regular to direct plans. But while doing so, don't forget to factor in exit loads and taxes.