India's mutual funds industry improves the global ranking on fees

The recent regulatory changes introduced by the Securities and Exchange Board of India (Sebi) have improved the global ranking of the country’s mutual fund (MF) industry in terms of the overall cost of investing, even as the cost of investing in equities remains high, according to the Global Investor Experience Study conducted by Morningstar.
 
The Morningstar’s biennial study noted that the cost of investing in debt (fixed-income) funds was much cheaper than equity funds. The asset-weighted median for fixed-income funds was relatively lower at 0.54 per cent, while those for equity and allocation funds were 1.78 per cent and 1.93 per cent, respectively.
 
The lower expenses in debt funds could be attributed to investors preferring the direct route for investing in debt funds. Direct plans typically have lower total expense ratios (TERs) than regular plans, in which distribution commissions are embedded within the TER.
 

However, India was among the four most expensive markets for investing in equity funds. Lack of retail investors’ appetite towards passive funds, ‘which tend to be much cheaper than their active counterparts’ can be one of the contributing factors. “The most expensive four markets for equity investment have almost no assets invested in passive open-end vehicles, on average,” the study said.
 
The study also noted that investors opting for the distributor-led mode of investing could be one of the reasons for the relatively higher asset-weighted medians.
 
“Assets in direct share classes have been rising gradually among investors who have partnered with fee-based advisors. Still, the majority of individual investors seek the services of mutual fund distributors and thus invest through a commission embedded plan, resulting in India’s relatively higher asset-weighted medians,” the study read.
 
However, Jeffrey Ptak, head of global manager research, Morningstar Research Services, clarified that focus of the study is not to show distribution in any negative light, but focus on the modes of compensation. “We have been proponents of ‘unbundled’ structures, wherein advisors can be compensated through fee-based models. Advisors play a critical role in ensuring investors stick to their long-term plans and they should be compensated for it. Fee-based models is a more transparent way to do this,” said Ptak.
 
The study highlighted that India’s grade on fees and expenses has improved from ‘below average’ in 2017 to ‘average’ in 2019. This has made India’s fees and expense structures favourable. Countries in the ‘below average’ grade include Germany, France, Belgium, and Canada. The other countries on the list include Hong Kong and Singapore. Italy and Taiwan are in the ‘bottom’ grade. The study pointed out that India had been among the most expensive geographies when it came to expense ratios, especially for equity and allocation funds. However, ‘with the recent expense cap reductions, India has seen a meaningful decrease in asset-weighted medians in this study’.
 
In September last year, Sebi capped the maximum limit on TERs to 2.25 per cent, from
2.5 per cent earlier, which was applicable on equity funds. The regulator also scrapped upfronting of commissions. While the move to cut TER has been welcomed by industry participants, MF distributors have expressed their misgivings with larger fund houses for passing on the bulk of these cuts to them.