On an average, mutual funds charge up to 2.50 per cent as fee. Of the 2.5 per cent, Sahara Wealth Plus charges 1.5 per cent of daily net assets for meeting third-party expenses and the additional 1 per cent management fee permissible under Sebi guidelines is the variable component pegged to the scheme’s performance.

While the move seems to make the fund manager accountable for his performance, there were some doubters. So here we have two head honchos debating the worthiness of a variable-fee structure.

Pankaj Razdan
managing director,
Prudential ICICI AMC

By virtue of regulation, the mutual fund industry offers investors professional fund management services at a cost that is globally regarded as among the lowest AMC fee.

The interest of the Indian mutual fund investor is already well-protected as the management fee that could be charged by an Indian mutual fund can’t exceed 1.25 per cent (125 basis points). Against this, in developed countries, the permissible range for pricing is significantly higher.

In a scenario like this, there is very little scope for having a variable component in the AMC fee structure that could be of material value to equity fund investors (currently, in India, this component can, at best, be 0.5 per cent for it to be viable for the fund).

Against this, in countries wherein regulations have laid a higher permissible ceiling for pricing, the performance-linked variable component of management fee could be fairly high, making a profit-sharing arrangement a sensible proposition for both – the investor as well as the fund house. In India, where there is a cap of 1.25 per cent on the management fee that could be charged by a fund house, the scope for variable fee or profit-sharing structure gets very restricted and, hence, may have little relevance in the context of long-term equity investments.

Having said that, if going forward Indian AMCs do get more flexibility in pricing management fee, I am certain that variable-fee structures would gain in popularity.

We believe that a 1.25 per cent management fee is a reasonable price to pay for a quality equity fund that holds great promise. During the last year, returns from equity funds across ranged 40-100 per cent. Given this stark difference in fund performance, an investor may focus energies on choosing the right fund that follows the right processes to help him achieve his objectives, than looking to save a 0.5 per cent variable fee in the event of fund falling short on performance.

Let’s see the importance of management fee in the context of equity funds against that of debt funds. In debt funds, where returns range 4 to 7 per cent, a 0.5 per cent reduction in management fee can give a huge boost to investor returns. Against this, even a modestly performing equity scheme has given annualised returns way in excess of 15 per cent in the last five years, making a 0.5 per cent variable fee component - that favours the investor under limited circumstances - insignificant.

We would recommend that a long-term equity investor – having identified his need and the nature of equity fund that satisfies it – may take several factors into account while choosing the equity fund that best suits his requirements. These factors include:

Parentage of the mutual fund

• Quality of management and administration
  
• Quality and adequacy of disclosures
  
• Service levels
  
• Performance record of the scheme
  
• Fund’s investment philosophy and processes
  
• The price at which you can enter/exit (i.e., entry/exit load) the scheme and its impact on overall return
• Expense ratio (including management fee)

Clearly, management fee is just one of the several considerations that should influence buying decision for an Indian equity fund investor who is looking at long-term capital appreciation. All of the above factors need to be closely evaluated before zeroing in on the fund that will be the perfect solution to meet ones’ financial goals.

Rajiv Shastri
chief executive officer,
Sahara Mutual Fund

Performance-linked fee achieves a focus and alignment of interests that have not existed in the industry

However, once a professional investment manager is appointed, the situation changes dramatically. Because the manner in which the investment manager is compensated for his services is then more important than the compensation itself. Should the investment manager be compensated for his services regardless of performance? If so, would they have their heart in their job? More importantly, would investors like to pay for their services at times when it is not satisfactory as well? Is it not important to ensure that the investment manager has a direct stake in performance?

An ideal compensation structure would address all these concerns in a pragmatic manner. The fixed fee structure that existed in the mutual fund industry does not do that. AMCs charge their investors a fee regardless of their performance. So what’s so ‘mutual’ about it?

The variable fee structure that we have pioneered through the launch of the Sahara Wealth Plus Fund has its root in our belief that investors do not deserve to pay for sub-standard investment management. We believe that we need to earn our fee, not charge it.

In addition to the tangible benefit that this offers our investors through lower expenses, there are enormous intangible benefits .

Firstly, unlike most other AMCs, size cannot be our only preoccupation. This is because, irrespective of size, we earn our fee only if our schemes perform. For us, performance is as important as size, as both have a direct impact on our earnings. Secondly, in a structure that is truly ‘mutual’, our need for performance is as great as our investors’. It achieves a focus and alignment of interest that have not existed in the industry thus far.

While there has been some initial resistance to this initiative from our industry peers, the variable-fee structure has ignited the interest of investors and distributors alike.

(The views expressed by the authors are their own and may not necessarily be subscribed to by the companies)