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No Free Lunch

New issues unload expenses on you no matter what they promise. Moreover you may be punished for being too loyal

How would you react if you found out that funds houses' new fund issues that claim to be without any load, the fund company actually charges to you a large part of the expenses that it incurs while marketing the issue? Not only that, they charge you this money by deducting it gradually over many years and the money that should be charged from investors who happen to disinvest from the fund is actually charged from investors who stay back! There have been funds where these charges have been as high as four to five per cent and not only that there appears to have been funds where for so many investors the effective charge paid by them may have been as high as 10 per cent.

Now, there will soon be a law asking fund companies to pay their own expenses or explicitly charge a load from investors up front. The current practice of maintaining a façade of being no load and actually charging the money later must stop.

Let's get a little clarity about what these expenses are and why they are charged. Fund companies, (Asset Management Companies or AMCs) have funds that are 'their own' in the sense that this is money invested by the AMC owners or money otherwise earned as profit by the AMC.

Bringing out a new fund issue is an expensive business. Advertising is expensive and getting people to buy your fund means spending a lot of money. And advertising is not the only big expense. For most funds, the commission that has to be paid to the distributors and salesmen, who actually come and pitch the fund to you, is the biggest cost for many funds. These expenses can be paid by the AMC itself or can be charged to investors. If it is to be charged to the investors then it can either be charged upfront as load or charged gradually over a long period. The route that some AMCs take, which to my mind is clearly unethical, is to create a no-load buzz up front and then keep charging the money over the next five years.

The basic principles are very clear -- fund companies must confess exactly how much money they are charging investors and they must not create grossly unfair rules that allow them to take one investors' money from another.

However, so self-evident are these principles and so deeply are they linked to the basic ethics of running a mutual fund, that it is more than a little disturbing that these practices will stop only after Sebi brings out a rule to stop them. The fund companies that are still behaving this way will no doubt tell you that this is a universal practice. But actually it isn't. Some fund companies have never done this and others have stopped voluntarily without waiting for Sebi to crack the whip.

The real issue that gets highlighted here is not arcane accounting details of how funds are run but the broader one of the intensity with which mutual funds need to be regulated in the country. People are finally entrusting Indian mutual funds with serious sums of money to invest and if some AMCs insist on sticking only to the barest minimum letter and not the spirit of the law, then the fund industry will do damage to the bright future that it surely has in this country.