Are High Value Investor Getting Short changed on Fees by Mutual Fund.

Commission based business is self killing.

Let’s take an example: Mutual Fund: SBI Blue Chip – Direct Plan.  Expense Ratio 2.5%

Expense ratio can be otherwise termed as fees or commission charged by mutual fund to it’s contributors.  The way it works is Funds perform in market and have certain mark to market Gross value. Fund house then charge fees on these funds and get net value.  NAV is calculated based on net value.

NAV = (Fund performance Gross value – Fees, expense etc) Total number of units.

So if an Investor “A” contributes has current contribution of 10,000 Rs and hence pays 2.5% i.e. 250 Rs towards expense.

Another investor “B” contributes 10,00,000 Rs then he pays 2.5%  i.e. 25,000 Rs towards expenses.

In my view there is extra work perhaps that was needed by managing larger fund. But was it directly proportional to amount invested. We have largely seen as fund sizes grow up there expense ratio (percentage) falls down. In fact there is perception and fund manager have neglected large funds and eventual performance declined  (will research and put in another post in future).

I think this all pay same ratio is more of socialist way of thinking. Fee normally includes administrative, account management fee and profit sharing fee. So how is it fare for large investor to pay bigger admi fee for his single folio compared too much smaller fee by smaller investor?  Isn’t  this Take money from Peter to subsidies against Paul’s expenses?  This is one of the behaviors high value investor start seeing more value in direct stock investment. Had the Expense ratio’s in India been o.2% it would have been perhaps no issue with 2.5% this difference is too big to ignore.

True source of expense (or near about true) should be identified and expenses should be on that. Entry load and exit loads were good but then they were [percentage based too no reflecting actual efforts for executing those transaction.

Here is what I think should happen.

Fixed Transaction Cost: There should be fixed fee in Rs not in percentages for each transaction and investor should pay this separately. Sip should have lower transaction cost since transactions are repetitive and in today’s word mostly automated. Someone who keeps buying and selling fund should pay for this.

Fund Management fee: There should be fixed fee for managing fund Irrespective of size. This should factor in fixed cost AMC expects. In fact there should be incentive for high value investor on this.

Expense ratio:  % Fee charged on funds much lower ratio should be charged on fun.

This is pretty much seemed to be the model in most developed countries. This keep cost of Staying invested in mutual fund low and investor even high net worth will stick around with god funds.  This will reduce MF hoarding behavior too since it would be beneficial to stick with fewer funds.

Is there a market for such rational fee structure in India?

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Mutual Fund Utilities – Welcome Move.

I am Big fan of Direct plan. One of the negative that most broker mention is you have to have manage multiple AMC relationships if you choose more than one AMC for investing. I think to some extent this is right complaint. if you ask me to choose between little bit of one time trouble and little extra money (about .050%) I would choose money. Bu then thats just me.

For those who would have chosen otherwise weighing in more on trouble of managing multiple account here is solution. Mutual fund utilities http://www.mfuindia.com/ is launched and running. MFU is created by partnership of several mutual fund houses, they offer Direct funds too. These are early days and account opening method is still old school. You have fill, print, sign and send opening form. Lot of MAC (for example UTI) does the same.  This I think will eventually improve but barring this one time hassles you can start investing in almost all major AMCS rom single place. Visit http://www.mfuindia.com/ for more details. Their FAQ is pretty elaborate as well.

Investing in Mutual Fund – Choose DIRECT Plans

When you invest in mutual fund and it is invested in various stocks and bond, there is cost incurred by AMC (asset management company) for managing this fund (like officer work, employee salaries amc profits etc). These are charged to customer in prorated fashion i.e. one with higher fund contribution pays more. This fee is called as Expense ratio. Expense ratio adjusted against actual portfolio value  and after this final per unit value (NAV) is declared. So NAV is net off all such fees.

NAV=(portfolio value – Expenses)/number of units

In terms of expense ratio;

NAV=portfolio value *(1-Expense ratio)/ number of units

So if there are 2 exact funds Fund A and Fund B one with higher expense ratio will have lower nav. And this is the exact case with Regular plan and DIRECT plan. There is about 0.50% to 0.80% difference in expense ratio in regular and direct plans.

Mutual fund distributors and brokers including online agents do not offer DIRECT mutual fund. In fact they do not even get feed for these, as regular funds are only option that allows commission kickbacks.

It do not make any financial sense to buy regular fund simply because you get same fund as DIRECT and pay little extra expense (ratio) which is then used to pay middle men.

I totally understand there is need for many people for research, portfolio management and advisory services. If you can get those from somewhere else like if you do your own MF research on websites like valueresearchonline.com DIRECT method has huge advantage over regular plan.

If you say what difference does .5% .6% does it make. Especailly if I have chosen good fund that earns 15% per year. In fact this difference make more sense if you fund make lot more money since that much less money is working for you.

Here is illustration of a fund with 10000 SIP over period of 15 years.

Consider Regular fund has expense ratio of 2.5 and direct version of same fund has expense ratio of 1.80%. and both had 15% return before expense ratio adjustment.

Here is table for Direct fund:

Previous Balance New
Puchase
Beginning Balance Fund Earnings (15%) Expense at 1.8% expense Ratio Net Earnings
(NAV based on this)
Endgin balance
0 120000 120000 18000 324 17676 137676
137676 120000 257676 38651 696 37956 295632
295632 120001 415633 62345 1122 61223 476855
476855 120002 596857 89529 1612 87917 684774
684774 120003 804777 120717 2173 118544 923321
923321 120004 1043325 156499 2817 153682 1197007
1197007 120005 1317012 197552 3556 193996 1511008
1511008 120006 1631014 244652 4404 240248 1871262
1871262 120007 1991269 298690 5376 293314 2284583
2284583 120008 2404591 360689 6492 354196 2758787
2758787 120009 2878796 431819 7773 424047 3302843
3302843 120010 3422853 513428 9242 504186 3927039
3927039 120011 4047050 607058 10927 596131 4643181
4643181 120012 4763193 714479 12861 701618 5464811
5464811 120013 5584824 837724 15079 822645 6407469
6407469 120014 6527483 979122 17624 961498 7488981
7488981 120015 7608996 1141349 20544 1120805 8729801
8729801 120016 8849817 1327473 23895 1303578 10153395
10153395 120017 10273412 1541012 27738 1513274 11786686

Now lets look at Regular plan

Previous Balance New
Puchase
Beginning Balance Fund Earnings (15%) Expense at 2.5% expense Ratio Net Earnings
(NAV based on this)
Endgin balance
0 120000 120000 18000 450 17550 137550
137550 120000 257550 38633 966 37667 295217
295217 120001 415218 62283 1557 60726 475943
475943 120002 595945 89392 2235 87157 683102
683102 120003 803105 120466 3012 117454 920559
920559 120004 1040563 156085 3902 152182 1192746
1192746 120005 1312751 196913 4923 191990 1504741
1504741 120006 1624747 243712 6093 237619 1862366
1862366 120007 1982373 297356 7434 289922 2272295
2272295 120008 2392303 358845 8971 349874 2742177
2742177 120009 2862186 429328 10733 418595 3280781
3280781 120010 3400791 510119 12753 497366 3898157
3898157 120011 4018168 602725 15068 587657 4605825
4605825 120012 4725837 708875 17722 691154 5416990
5416990 120013 5537003 830550 20764 809787 6346790
6346790 120014 6466804 970021 24251 945770 7412574
7412574 120015 7532589 1129888 28247 1101641 8634230
8634230 120016 8754246 1313137 32828 1280308 10034554
10034554 120017 10154571 1523186 38080 1485106 11639678

So if you Invest in Direct plan in this case you make 147000 money at end. I am all in for not loosing any free money.

Investing in Mutual Fund – Choose DIRECT Plans. Its a no brainer.

Here is case of Revising tax system (Individual taxes)

Have you ever wondered why your salary slip look so messy with so many head of incomes Most other country have single head of income – “Wages” and  bunch of tax deduction. There are very many intrinsic flaws with current individual tax  system. For this post I will restrict discussion to salaried individual tax deduction.

What are deductions: Governments announce tax breaks (deduction) on certain expenditures to promote those expenditures. I think Indian tax system some of these are largely misplaced.

HRA / Home loan interest waiver:

I know these are under different clause. By giving this waiver government is trying to promote owning house and renting both. India is amongst very small number of countries subsidies renting. It was envisioned  this way several decades ago.

Let’s look at HRA laws it is allows you certain % x of basic with maximum limit and it up to employer to provide this hra or not.  What does employer has to do with renting. Why not aggregate this amount in wages and simplify law to allow deduction up to certain percent y from this total amount toward house rent.

Only people left out are who are staying in paid up houses.

Income tax also makes criminals out of many of us.Fake bills, fraud notarized agreements are rampant. People who cannot get this break someone living with parents or husbands fake this all the time. This I believe promotes mentality of tax evasion.

80C:

When tax laws were written 80c was introduced to inspire investments and habit of saving. This gave birth to ppf, kisan vikas and indira vikas and various postal schemes. This was perhaps the need of time; people of India have in general understood saving is important. There no more a need of promoting this. But this clause stays with most of the schemes with small lock in of 3 years. Most people invest and keep recycling them every 3 years effectively not preparing them for long term goal like retirement. Also this is one crowded space with all kinds of proven bad products.

There are far better social priorities like education, medical insurance life insurance retirement (long term locking like NPS) that are not getting truly promoted with this. Some of these are addressed in other clauses however life insurance is mixed of often time with investment in the form of ridiculous ULIPs

I think govt should abolish 80c completely and create new deduction (or change 80c) to include such priorities.

Medical Bill, Telephone Bill, Fuel Bull: This is another ridiculous deduction; first of all 15k is lousy amount for any family for medial expenses. Second why your employer does has to put it as separate line item. Why not just add this amount to tax free income. No more bill collection, submission, auditing.

Sodexo: Only people making money in this are sodexo ( and similar organization). This has been hassle for employer, employee grocery stores and restaurants. If govt really want to subsidize office lunches why not just make this much amount tax free why go thru pain of creating another crazy payment system.

Suggestions:

  • Make Wages and pay slips simple with as single income head from salary and bonus. No more, TA, DA, HRA, Medical telephone allowance, sodexo.
  • Any perks company want to pay should pay as salary and keep break up internally.
  • Come up with Standard tax free limit that compensates for al removed tax free heads.
  • Revise deductions use them to push long term social agenda. I think below should be deduction
    • Education Interest waiver.
    • Home loan interest waiver.
    • Disability Waiver
    • Medical Insurance
    • Term Life insurance premium No ULIP or mixed products.
    • Retirement Plan – NPS, Govt criteria regulated private funds (open for all fund houses) locking period till age 58 or in that range, no annuity requirement and flexibility to employee would be better. Heavy penalty on early withdrawals.
    • Charity To very little organization – Capped.
    • Tax credits for Old Age dependent, adoption etc
    • Home ownership cost like property tax should be waived form income tax
  • All deduction should be capped and auto adjusted every year based on inflation. No more yearly announcements.
  • Make tax brackets in increments of 5 % with smaller bracket sizes.

Why Mutual Funds are not Popular in India

If you talk to any decent retail investor in developed country like USA people usually go mutual fund route for stock market investing. After all mutual funds are supposed to be Money saver for common man. MF has received very cold response and poor growth in India even compared to Direct stock options. Here are some of the reason I think why.

Distributor / Broker low interest:

Boring common sense investments is still not picked up in India. with Information overload boom of 2000s this situation is improving but still most of the market is captured by distributors. With few changes (good) in no  entry load and regulated expense ration distributors lost interest in mutual funds. whereas same broker houses make decent killing in continuous trading as brokerage.

Cost differential:

Mutual fund in India are expensive in general expense ratio are about 2.5%  even index funds are above 1/25% compared to as low as 0.18% in most developed countries. So many low cost brokerage on stock allows you to easily do buy and hold at much lower cost. This hits fund performance and in turn make them bad looking in comparison. Most people prefer to buy stocks directly and MF houses have failed big time to educate investor to use their services.

Tax Treatment:

There is is hardly any focus on retirement planning in India. Traditionally ‘my son will take care of me’ or govt job pension managed this for most people. Government piratically failed to motivate this via ta rebates for real really long term investment.While govt had been handing over 80C benefits for as low as 3 year long locking periods. There is no focus on retirement funds. 80c space is highly crowded and includes fixed return and lucrative sovereign products.

Competition with Physical Assets:

Real estate and Gold are still dominate Indian minds, and structured financial investment still has long way to go.