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Nibbling away your returns

The commission charged by fund houses on investment in mutual funds where no intermediary has been used, is unjustified.

"It’s unfair on the part of a fund house to use investors’ money to meet marketing expenses"

—Dhirendera Kumar, CEO, Value Research Online

Assume that you invest Rs 1 lakh in two mutual fund schemes (Rs 50,000 in each), both of which offer the same rate of return. At the end of 20 years, you find that you have Rs 29,294 more in one fund. All else being equal, you notice that the second fund has been charging you a “trail commission” of 0.5 %.

Did you know about the existence of this charge? More importantly, did you realise it would have such an impact on your returns? Trail or trailing commission is an annual fee that’s generally hidden in the expense ratio of the fund. This commission is over and above the 2-2.5% entry load that is deducted when an investor enters a mutual fund scheme through a distributor.

Those buying directly from the mutual fund are not charged an entry load. Unlike the entry load, the trail commission is deducted whether or not you come in through a distributor. The commission is levied on the market value of the investment amount and remains the same throughout the period. The higher the market value of your investment, more is the money made by the distributor. Though the percentage of trailing commission is small and may not have any significant effect on your returns in the short term, it can impact your returns hugely over a longer period of time.

How trailing commission matters

 Fund A
(No trail commission)
Fund B
(Trail commission)
Benefit to investor
(in RS)(in %)
Amount invested (Rs)50,000
50,000


Return*10%
10%
Trail Commission0.00%0.50%
Value after 10 years (Rs)
12,968712,39115,7764.66
Value after 15 years (Rs)20,886219,506613,7967.07
Value after 20 years (Rs)33,6375
30,7081

29,2949.54

There seems to be some justification for charging this fee and passing it on to the distributor. That’s because you might get valuable investment advice from the distributor—often worth more than the trailing commission. But what happens when you invest directly? Strangely, the fund still deducts this commission—and pockets it. Most fund houses use this commission to meet other marketing expenses of the fund.

Says Krishnamurthy Vijayan, CEO, JP Morgan Mutual Fund: “Trail commissions remain in the net asset value (NAV) of the fund. It can also be used for other marketing expenses as part of the expense ratio depending on the situation.”

Mutual fund experts, however, say that this is wrong. “A fund house should not use the money that belongs to the investors for meeting the marketing expenses,” says Dhirendera Kumar, CEO, Value Research Online. Adds Devendra Nevgi, CEO and CIO, Quantum Mutual Fund: “If there is no distributor involved, the commission should not be charged at all.”

Ever since the Securities and Exchange Board of India (Sebi) came out with its regulation early this year scrapping the entry load on direct mutual fund investments, the number of direct investors has gone up by 5%. Since then, a lot of money has found its way directly to fund houses, and this should ideally come back to the investors in some form.

Of course, distributors say that this is not an ideal situation. Most of them feel that direct investors should be provided a form that has the option of allowing or disallowing the trailing commission to the distributor of their choice. “Such an option would help the direct investors avail of the advisory facility with the distributor, and at the same time make their investment cost-effective due to the absence of entry load,” says Prateek Jain, mutual fund research analyst, Way2Wealth, a distribution house.

On their part, the fund houses might consider putting the commission amount back into the NAV of the fund if the number of direct investors reaches critical mass. Says Kumar: “It should not be deliberated upon, but implemented immediately. Ideally, there should be a separate plan for direct investors where the expenses are kept low. It is possible as there already are different plans for retail and institutional investors. Institutional investors are not charged the entry load even if they invest through a distributor, but they have to pay the trailing commission.”

Mutual funds are not likely to stop deducting this commission unless they are issued a clear directive to this effect. After all, it’s easy money and there’s nothing that says they should not deduct this amount. We repeatedly tried to contact the regulator for an official word on the issue. But for an entire month between June and July, it failed to respond.

What is this expense

• Trailing Commission is a part of the expense ratio

• It is given to the distributor by the fund houses as an incentive

• As long as the investor remains invested in the fund house, the distributor is entitled to the commission

• It varies from 0.25% to 0.5% per annum for equity funds, but is negligible for debt and liquid funds

• It is charged on the market value of the assets

• In case of direct investment, fund houses take the place of a distributor and keep the amount themselves