India most expensive for equity schemes? Morningstar clarifies its stance

While the Foundation of Independent Financial Advisors contended India was the third least expensive for equity schemes, Morningstar's GFIE 2017 report claimed India was among the most expensive

Is India really one of the most expensive markets for equity schemes as independent investment research firm Morningstar claims? Or is it actually the third least expensive, as contended by the distributor body Foundation of Independent Financial Advisors (Fifa)?

According to Morningstar's Global Fund Investor Experience (GFIE) 2017, of the 25 countries that were reviewed, India was among the most expensive for equity schemes.

After Morningstar India Managing Director Aditya Agarwal's tweet challenging Fifa’s contention led to a backlash on the social media platform, the investment research firm on Monday explained its position on its website.

"India received the highest grade for disclosures but was rated below average for fees and expenses. India did not receive the lowest grade for fees and expenses and was one of nine countries to receive a below average grade in this area. We categorically state that ‘us against the Indian funds industry’ slant is completely baseless and unfounded," read the post.

Morningstar explained its observation of India being among the most expensive geographies. "While the GFIE 2017 states that India is among the most expensive geographies when it comes to expense ratios for equity and allocation funds, and these elements fall behind global best practices, it also adds that the situation is not unusual, given the developing nature of the Indian fund market and the impact this has on scale and distribution."

As for Fifa’s specific argument that the GFIE report has compared the cost of bundled funds (embedded funds) and unbundled funds without making the necessary adjustments, Morningstar said it had openly called out the issues related to bundled versus unbundled fee comparisons. "For the purpose of this study, we have also taken the stance that unbundled fee structures are better for investors than bundled structures. There are three main reasons for this (across all markets) – it provides better disclosure, there is more focus on each part of the value chain, and cheaper funds become available to investors,” the firm said.

“An ongoing service fee negotiated with a client is likely to result in better services provided to the investor than a trail commission automatically paid by a fund. Likewise, a fee for initial advice agreed with a client is better than a front load.”

Raising more “challenges” to Fifa’s assumptions in its report, Morningstar said 16 per cent of the equity assets in India came from direct plans. If Fifa had chosen to add an assumed advisory fee component to costs in other geographies, it should do the same for direct plans for equity funds in India. “As described… we do not believe this approach makes sense for comparison. The Fifa study excluded the tax component (VAT/GST) from the expense ratio. We are not sure how prudent a move that is as the burden will invariably fall on the investor, and there is no way that s/he can avoid it,” Morningstar said.

The firm also questioned Fifa's assumption that the difference between the expense ratios of regular plans and direct plans was the distribution cost in India. Data on actual commissions paid to distributors were available. An examination of the factual data was likely to be more instructive than assumptions, it said.

Concluding its response, Morningstar said the GFIE was never meant to be a definitive study on expense ratio levels. Rather, it was a measure of investor experience and the aim had been to promote healthy dialogue about what constituted best practices. “We are glad that the India market has taken cognizance of the report and is debating best practices. There are challenges comparing bundled with unbundled markets, but what could not be determined with surety did not form part of our analysis as that would lead to a misconstrued conclusion."

Morningstar said it firmly stood behind the grades that were issued.